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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTER ENDED AUGUST 31, 2002
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-27046
TRAFFIX, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 22-3322277
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
ONE BLUE HILL PLAZA
PEARL RIVER, NEW YORK 10965
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (845) 620-1212
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
The number of shares outstanding of the Registrant's common stock is
14,478,972 (as of 10/11/02).
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TRAFFIX, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
QUARTER ENDED AUGUST 31, 2002
ITEMS IN FORM 10-Q
PAGE
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements ....................................................... 2
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ................................................... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk ................. None
Item 4. Controls and Procedures .................................................... 43
PART II OTHER INFORMATION
Item 1. Legal Proceedings .......................................................... 44
Item 2. Changes in Securities and Use of Proceeds .................................. None
Item 3. Defaults Upon Senior Securities ............................................ None
Item 4. Submission of Matters to a Vote of Security Holders ........................ 44
Item 5. Other Information .......................................................... None
Item 6. Exhibits and Reports on Form 8-K ........................................... 45
SIGNATURES ............................................................................. 46
1
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AUGUST 31, NOVEMBER 30,
2002 2001
------------ ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents ................................................ $20,123,520 $14,458,055
Marketable securities .................................................... 19,480,871 23,677,999
Accounts receivable, trade, net of allowance for doubtful accounts
of $274,850 at August 31, 2002 and $383,676 at November 30, 2001 ....... 6,894,648 7,326,032
Deferred income taxes .................................................... 1,733,282 3,242,815
Due from related parties ................................................. 180,567 106,654
Prepaid expenses and other current assets ................................ 1,679,541 1,415,836
----------- -----------
TOTAL CURRENT ASSETS .............................................. 50,092,429 50,227,391
Property and equipment, at cost, net of accumulated depreciation ............ 1,918,987 951,702
Goodwill and other intangibles, net ......................................... 2,971,638 1,362,407
Deferred income taxes ....................................................... 147,084 147,084
Other ....................................................................... 54,000 54,000
----------- -----------
TOTAL ASSETS ...................................................... $55,184,138 $52,742,584
=========== ===========
LIABILITIES
Current liabilities:
Accounts payable ......................................................... $ 2,098,230 $ 3,928,418
Accrued expenses ......................................................... 7,769,882 4,098,921
Due to related parties ................................................... 587,026 469,935
Income taxes payable ..................................................... -- 1,672,953
----------- -----------
TOTAL CURRENT LIABILITIES ......................................... 10,455,138 10,170,227
----------- -----------
Minority interest ........................................................... 423,869 159,651
----------- -----------
SHAREHOLDERS' EQUITY
Preferred stock-- $.001 par value; 1,000,000 shares authorized;
none issued and outstanding .............................................. -- --
Common stock-- $.001 par value; authorized 50,000,000 shares; issued
14,518,146 shares and 14,290,491 shares, respectively .................... 14,518 14,289
Common stock issuable-- $.001 par value; 78,347 shares ...................... 485,758 --
Additional paid-in capital .................................................. 42,646,569 41,395,784
Retained earnings ........................................................... 5,431,610 3,206,770
Accumulated other comprehensive income ...................................... 18,051 72,577
Common stock held in treasury, at cost, 1,474,777 and 961,403
shares, respectively ..................................................... (4,291,375) (2,276,714)
----------- -----------
TOTAL SHAREHOLDERS' EQUITY ........................................ 44,305,131 42,412,706
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ........................ $55,184,138 $52,742,584
=========== ===========
The accompanying notes are an integral part of these financial statements.
2
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- --------------------------
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
2002 2001 2002 2001
------------ ------------ ----------- ------------
Net revenue ...................................... $10,664,246 $ 7,404,820 $33,839,681 $18,158,917
Cost of sales .................................... 3,218,160 2,281,715 9,979,975 4,907,317
----------- ----------- ----------- -----------
GROSS PROFIT ................................ 7,446,086 5,123,105 23,859,706 13,251,600
Selling expenses ................................. 3,133,682 663,549 8,650,996 1,653,635
General and administrative expenses .............. 3,665,681 2,954,674 11,216,152 8,077,236
Bad Debt expense ................................. 48,941 -- 487,447 --
----------- ----------- ----------- -----------
INCOME FROM OPERATIONS ...................... 597,782 1,504,882 3,505,111 3,520,729
Other income (expense):
Interest expense .............................. (7,865) -- (27,633) --
Interest income and dividends ................. 190,805 353,645 584,404 1,497,906
Realized gains on marketable securities ....... 2,664 405,837 85,821 404,061
Permanent impairment charges .................. -- -- -- (4,690,258)
Other non-operating income (expense) .......... (456,989) (4,060) (221,887) 84,290
Minority interest in (income)
loss of subsidiary .......................... (148,782) -- (279,731) --
----------- ----------- ----------- -----------
INCOME BEFORE PROVISION
FOR INCOME TAXES ............................ 177,615 2,260,304 3,646,085 816,728
Provision for income taxes ....................... 69,235 797,312 1,421,245 2,109,111
----------- ----------- ----------- -----------
NET INCOME (LOSS) ........................... $ 108,380 $ 1,462,992 $ 2,224,840 $(1,292,383)
=========== =========== =========== ===========
Basic income (loss) per share (Note 3):
Net income (loss) ............................. $ 0.01 $ 0.10 $ 0.17 $ (0.09)
----------- ----------- ----------- -----------
Weighted average shares outstanding ........... 13,168,407 13,966,939 13,454,093 14,497,515
=========== =========== =========== ===========
Diluted income (loss) per share (Note 3):
Net income (loss) ............................. $ 0.01 $ 0.10 $ 0.15 $ (0.09)
----------- ----------- ----------- -----------
Weighted average shares outstanding ........... 13,895,370 14,729,475 14,548,047 14,497,515
=========== =========== =========== ===========
The accompanying notes are an integral part of these financial statements.
3
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED AUGUST 31, 2002
(UNAUDITED)
COMMON STOCK ADDITIONAL TREASURY STOCK
----------------------- COMMON STOCK PAID-IN RETAINED ---------------------
SHARES AMOUNTS ISSUABLE CAPITAL EARNINGS SHARES AMOUNT
----------- --------- ---------- --------- ---------- --------- --------
BALANCE, NOVEMBER 30, 2001 ........ 14,290,491 $ 14,289 $ -- $41,395,784 $3,206,770 961,403 $(2,276,714)
Unrealized (losses) on available
for sale securities.............
Stock option exercises ............ 188,481 189 584,377
Tax benefit from exercise of
stock options .................. 309,166
Common stock issued in
connection with acquisition .... 39,174 40 242,840
Common stock issuable in
connection with acquisition .... 485,758
Net proceeds on non-management
trading gain disgorgement ...... 114,402
Foreign Currency Translation
adjustment......................
Purchase of common stock,
held in treasury, at cost ...... 513,374 $(2,014,661)
Net income for the nine months
ended August 31, 2002 .......... 2,224,840
---------- -------- --------- ----------- ---------- --------- -----------
BALANCE, AUGUST 31, 2002 14,518,146 $ 14,518 $ 485,758 $42,646,569 $5,431,610 1,474,777 $(4,291,375)
========== ======== ========= =========== ========== ========= ===========
ACCUMULATED
OTHER TOTAL
COMPREHENSIVE SHAREHOLDERS'
(LOSS) INCOME EQUITY
--------------- -------------
$ 72,577 $42,412,706
(53,819) (53,819)
584,566
309,166
242,880
485,758
114,402
(707) (707)
(2,014,661)
2,224,840
-------- -----------
$ 18,051 $44,305,131
======== ===========
The accompanying notes are an integral part of these financial statements.
4
TRAFFIX, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
------------------------------
AUGUST 31, AUGUST 31,
2002 2001
-------------- -------------
Cash flows from operating activities:
Net income (loss) ....................................................... $ 2,224,840 $ (1,292,383)
Adjustments to reconcile net income (loss) to net cash used in
operating activities:
Depreciation and amortization ......................................... 804,241 272,916
Reserve for customer chargebacks ...................................... -- 15,081
Provision for uncollectible accounts .................................. 487,447 1,038,481
Deferred income taxes ................................................. 1,509,533 (2,971,500)
Compensation expense related to stock options ......................... -- 116,218
Net (gains) on sale of marketable securities .......................... (85,846) (404,061)
Permanent impairment charges .......................................... -- 4,690,258
Amortized discounts and premiums on marketable securities ............. (50,664) (302,995)
Minority interest ..................................................... 264,218 --
Changes in assets and liabilities of business:
Accounts receivable ................................................ (56,062) (3,983,670)
Prepaid expenses and other current assets .......................... (263,705) 380,413
Accounts payable ................................................... (1,830,188) (681,514)
Income taxes payable ............................................... (1,363,786) (534,856)
Due from/to related parties ........................................ 43,178 (859,608)
Other, principally accrued expenses ................................ 3,185,682 278,498
----------- -----------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES .............. 4,868,888 (4,238,722)
----------- -----------
Cash flows from investing activities:
Purchases of securities ................................................. (142,524,298) (173,426,992)
Proceeds from sales of securities ....................................... 146,804,117 187,993,483
Capital expenditures .................................................... (1,618,362) (546,968)
Payments for asset acquisitions, net of cash received ................... (548,482) --
Purchases of long-term investments ...................................... -- (49,000)
----------- -----------
NET CASH PROVIDED BY INVESTING ACTIVITIES ........................ 2,112,975 13,970,523
----------- -----------
Cash flows from financing activities:
Purchases of common stock ............................................... (2,014,661) (6,048,662)
Proceeds from stock options exercised ................................... 584,567 200,933
Proceeds-net on settled Section 16-b action ............................. 114,403 --
----------- -----------
NET CASH USED IN FINANCING ACTIVITIES ............................ (1,315,691) (5,847,729)
----------- -----------
Effect of exchange rate changes on cash and cash equivalents ............ (707) --
Net increase in cash and cash equivalents ............................... 5,665,465 3,884,072
Cash and cash equivalents, beginning of period .......................... 14,458,055 4,551,344
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................................ $20,123,520 $ 8,435,416
=========== ===========
During the nine months ended August 31, 2002, the Company has 117,521 shares
of common stock issued and issuable, valued at $728,636 in the purchase of the
assets of a closely held, private company (See note 9.)
The accompanying notes are an integral part of these financial statements.
5
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. GENERAL
The accompanying unaudited consolidated financial statements of the Company
have been prepared in accordance with generally accepted accounting principles
for interim financial information. Accordingly, the unaudited consolidated
financial statements do not include certain information and note disclosures
normally required by generally accepted accounting principles. The accompanying
unaudited consolidated financial statements reflect all adjustments (consisting
only of normal recurring adjustments) which are, in the opinion of management,
necessary for a fair presentation of the financial position and operating
results for the interim periods presented. In the preparation of these financial
statements, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the interim periods reported. Actual results could differ from
those estimates. Principally, estimates are used in accounting for bad debts and
sales allowances, depreciation and amortization, income taxes and contingencies.
Managements' estimates and assumptions are continually reviewed against actual
results with the effects of any revisions being reflected in the results of
operations at that time. The accompanying unaudited consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto, together with management's discussion and analysis
of financial condition and results of operations, contained in the Company's
Annual Report on Form 10-K for the fiscal year ended November 30, 2001. The
results of operations for the three and nine month periods ended August 31, 2002
are not necessarily indicative of the results to be expected for the subsequent
quarter or the entire fiscal year ending November 30, 2002. Certain prior year
amounts in the unaudited consolidated financial statements have been
reclassified to conform with the current year presentation.
During the nine months ended August 31, 2002 and 2001, options for 188,481
shares and 122,651 shares of the Company's common stock, respectively, were
exercised by certain employees and directors. Tax benefits of $309,166 and
$89,040 in nine months ended August 31, 2002 and 2001, respectively, were
recorded as an increase to additional paid-in capital and a reduction of income
taxes currently payable.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141
requires that all business combinations be accounted for by the purchase method
of accounting and changes the criteria for recognition of intangible assets
acquired in a business combination. The provisions of SFAS 141 apply to all
business combinations initiated after June 30, 2001. We do not expect that the
adoption of SFAS 141 will have a material effect on our consolidated financial
position or results of operations. SFAS 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, once SFAS
142 is adopted, which will be in our fiscal year ending November 30, 2003;
however, these assets must be reviewed at least annually for impairment
subsequent to adoption. Intangible assets with finite useful lives will continue
to be amortized over their respective useful lives. The standard also
establishes specific guidance for testing for impairment of goodwill and
intangible assets with indefinite useful lives. The provisions of SFAS 142 will
be effective for our fiscal year ending November 30, 2003, earlier adoption was
not elected by the Company pursuant to the terms of SFAS 142. However, goodwill
and intangible assets acquired after June 30, 2001 are subject immediately to
the non-amortization provisions of SFAS 142. While we are currently in the
process of evaluating the potential impact that the adoption of SFAS 142 will
have on our consolidated financial position and results of operations, our
preliminary assessment is that the adoption of SFAS 142 will have an immaterial
impact on the Company.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations". SFAS 143 sets forth the guidelines regarding the
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and any costs associated with the
related assets' retirement. The provisions
6
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
of SFAS 143 will be effective for our fiscal year ending November 30, 2003.
Based on the relative components of our balance sheet at August 31, 2002 we
believe that the adoption of SFAS 143 will have an immaterial impact on the
Company's consolidated financial position and results of operations, if any
effect at all.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS 144 amends existing
accounting guidance on asset impairment and provides a single accounting model
for long-lived assets to be disposed of. Among other provisions, the new rules
change the criteria for classifying an asset as held-for-sale. The standard also
broadens the scope of businesses to be disposed of that qualify for reporting as
discontinued operations, and changes the timing of recognizing losses on such
operations. The provisions of SFAS 144 will be effective for our fiscal year
ending November 30, 2003 and will be applied prospectively. We are currently in
the process of evaluating the potential impact that the adoption of SFAS 144
will have on our consolidated financial position and results of operations.
Based on the relative components of our balance sheet at August 31, 2002 we
believe that the adoption of SFAS 144 will have an immaterial impact on the
Company's consolidated financial position and results of operations, if any
effect at all.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB No. 13, and Technical Corrections". SFAS 145
promulgates rules regarding the financial accounting and reporting requirements,
which include gains and losses resulting from the extinguishments of debt and
the treatment of sale-leaseback transactions. The provisions of SFAS 145 will be
effective for our fiscal year ending November 30, 2003. Based on the relative
components of our balance sheet at August 31, 2002 we believe that the adoption
of SFAS 145 will have an immaterial impact on the Company's consolidated
financial position and results of operations, if any effect at all.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS 146 promulgates rules
regarding exit or disposal activities that are initiated after December 31,
2002. SFAS 146 requires companies to recognize costs associated with the exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan and nullifies the requirements under the
"Emerging Issues Task Force No. 94-3", "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity (Including
Certain Costs in a Restructuring)". The Company believes that the adoption of
SFAS 146 will have an immaterial impact on the Company's consolidated financial
position and results of operations, if any effect at all.
2. SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
The Company currently earns the most significant portion of revenue from
its E-commerce segment pursuant to marketing agreements with marketing partners
and corporate customers (collectively, "Corporate Customers"). The provisions of
each agreement determine the type and timing of revenue to be recorded. The
Company generates its E-commerce revenue from the following eight basic
categories: (1) delivery of consumer traffic to the websites and inbound
telemarketing call centers of our Corporate Customers (e.g., click-thrus from
the game banners on the Company's websites), (2) delivery of consumer data to
our Corporate Customers with respect to the consumers who have registered for
our Corporate Customers' products or services (e.g., a consumer who registered
via the registration page of one of the Company's websites to receive on-line
promotions from our Corporate Customers), (3) delivery of pre-qualified consumer
data to our Corporate Customers as a result of consumers' responses to targeted
questions and surveys (e.g., do you need a new credit card?), (4) delivery of a
sale or completed application for our Corporate Customers' products or services
(e.g., a consumer who responds to a Traffix e-mail promotion on behalf of a
Corporate Customer and purchases a product with a credit card), (5) generating
revenue from any of the foregoing categories by placing our Corporate Customers'
offers on the
7
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
media of third parties with whom we have a marketing relationship on a revenue
share basis, (6) sales of Traffix's proprietary products and services directly
to consumers (e.g., jewelry, voicemail, dvd's and books), (7) rentals and sales
of copies of specific segments of our databases to Corporate Customers for their
proprietary marketing and database enhancements, and (8) customer acquisition
services, both on-line and off-line, under a net branch agreement with qualified
mortgage banking establishments.
The Company invoices its customers in accordance with the terms of each
underlying agreement. Revenue is recognized at the time the marketing activity
is delivered, or service is provided, net of estimated contractually specified
data qualification allowances, when applicable. Such data qualification
allowances may include duplications, invalid addresses, age restrictions and
other allowances, and are recorded as contra revenue. Historically, the variance
between actual allowances and previously estimated allowances has been
immaterial. In accordance with revenue recognition pronouncements, specifically
Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements"
("SAB 101") issued in December 1999, and in accordance with the Company's
historical accounting policies and reporting practices, the Company records all
related obligations associated with the related net revenue at its point of
recognition. The Company adopted SAB 101 during the first three months of the
fiscal year ended November 30, 2001. Such adoption did not materially impact our
financial position or results of operations at that time.
Revenues from the Company's off-line customer acquisition services segment
currently include the revenue earned by Montvale Management, LLC, the Company's
majority owned subsidiary. Such revenues are currently 12% of the Company's
consolidated net revenues for the nine months ended August 31, 2002, and result
from Montvale's provision of net branch services to mortgage banking and other
related financial institutions. Approximately 15% of Montvale's revenues are
derived from on-line sources, with such portion being included in the Company's
E-commerce segment. Montvale recognizes income in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 91, "Accounting for Non Refundable
Fees and Costs Associated with Originating or Acquiring Loans". Pursuant to SFAS
No. 91, Montvale recognizes its commission upon the disbursement of loan
proceeds.
Prior to September 1, 2001, revenues from the Company's off-line customer
acquisition services consisted of residential long distance customer acquisition
programs, and were recorded upon the achievement of certain events particular to
the corresponding program's fulfillment liability. Subsequent to the delivery of
the initial sales record to the respective long distance carrier, the Company
may have been required to provide to the customer certain products and services
(fulfillment liability), such as prepaid cellular telephones and/or other
suitable premiums. These costs were estimated and accrued, based upon historical
rates and costs, as a component of marketing expense and included in the cost of
sales, at the time the associated revenues were recognized. The Company's
current business, as conducted in its E-commerce segment, in certain cases also
requires the provision of a premium. These E-commerce segment premiums are
estimated and accrued, based upon historical and current experience. Such
E-commerce premium costs are classified as a component of marketing expense and
included in the cost of sales, at the time the associated revenues are
recognized. Any variance in the initial accrual as compared to the actual
experience is taken into operations in the period that the variance is
determinable.
Revenue from the Company's LEC Billed Product and Service segment (the
Company has not marketed such services since November 1998, but had recorded
residual revenue from such segment during the three months ended August 31,
2002), consisted of various enhanced telephone services, principally voice mail
services, and were recognized net of an estimated provision for refunds and
credits subsequently granted to customers ("customer chargebacks"). Since the
provision for customer chargebacks was established prior to the periods in which
chargebacks are actually expended, the Company's revenues are adjusted in later
periods if the Company's incurred
8
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
chargebacks varied from the amounts previously estimated. The Company's LEC
Billed Product and Service segment was inactive during the nine months ended
August 31, 2002.
With respect to capitalization and amortization of marketing costs, the
Company's policy is to expense, as a cost of sale, data acquisition costs and
all other related marketing costs, at the time an obligation or expense is
incurred.
TRANSACTIONS WITH MAJOR CUSTOMERS
During the three and nine months ended August 31, 2002, the Company had
five major customers in its E-commerce segment, which in combination accounted
for approximately $5.2 million and $18 million of consolidated net revenue,
respectively, or 49% and 53% of consolidated net revenues, respectively.
Approximately $4.5 million, or 65% of consolidated net accounts receivable was
attributable to such major customer group as of August 31, 2002. For the three
and nine months ended August 31, 2002, one of these customers accounted for net
revenues that equaled or exceeded 10% of the Company's consolidated net revenue
for such period. The five major customers accounted for 24%, 7%, 7%, 6% and 5%
of consolidated net revenue, respectively, for the three months ended August 31,
2002, and 25%, 8%, 8%, 7% and 5% of consolidated net revenue, respectively, for
the nine months ended August 31, 2002. Of the remaining approximate 100 active
customers in the three and nine months ended August 31, 2002, no other single
customer had net revenue that equaled or exceeded 2% of consolidated net
revenue.
The Company continued to conduct business with all such five major
customers as of October 8, 2002. The customer which accounted for 25% of the
Company's net revenues for the nine months ended August 31, 2002 has notified
the Company that it is exercising its right to terminate its agreement with the
Company, and, as such, will phase out its business with the Company over a
ninety day period ending December 7, 2002.
During the three and nine months ended August 31, 2001, the Company had
four customers in its E-commerce segment which, in combination, accounted for
approximately 50.6% and 47.4% of consolidated net revenues, respectively, and
approximately 30.8% of consolidated net accounts receivable as of August 31,
2001.
3. EARNINGS PER SHARE
The following table sets forth the reconciliation of the weighted average
shares used for basic and diluted earnings per share:
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------- --------------------------
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Denominator:
Denominator for basic earnings per share--
weighted average shares ..................... 13,168,407 13,966,939 13,454,093 14,497,515
Effect of dilutive securities:
Stock options ............................... 726,963 762,536 1,093,954 --
------------ ----------- ----------- -----------
Denominator for diluted earnings
per share-- adjusted weighted
average shares .............................. 13,895,370 14,729,475 14,548,047 14,497,515
============ =========== =========== ===========
Options to purchase 1,429,333 and 881,500 shares of common stock for the
three months ended August 31, 2002 and 2001, respectively, and 659,778 and
858,613 for the nine months ended August 31, 2002 and 2001, respectively, were
outstanding but were not included in the computation of diluted earnings per
share because their effect would be anti-dilutive.
9
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
4. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is defined as "the change in equity of a
business enterprise during a period from transactions and other events and
circumstances from non-owner sources." Excluding net income, the Company's
primary sources of comprehensive income (loss) would ordinarily include the
after-tax net unrealized gains and (losses) on available-for-sale securities,
and the equity adjustment from foreign currency translation. Based on prior
fiscal year unrealized capital losses in excess of the current year's three and
nine month period's unrealized gains, a full credit has been taken against the
estimated deferred tax liability attributable to the unrealized gains arising in
the three and nine month periods ended August 31, 2002. At November 30, 2001,
full valuation allowances were taken against the estimated deferred tax assets
attributable to the unrealized losses based on the absence of other appreciated
capital gain property. The components of comprehensive income (loss) are
presented below:
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------- --------------------------
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net income (loss) .............................. $108,380 $1,462,992 $2,224,840 $(1,292,383)
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments ......... 20,081 -- (707) --
Unrealized gain(loss) from available-for-sale
securities, arising during the period,
net of income taxes of $-0- .................... (83,555) 17,874 (53,819) 241,150
Less: reclassification adjustment for loss
realized in net income ......................... -- -- -- 4,190,207
Add: reclassification adjustment for gain
realized in net income ......................... -- (405,837) (404,061)
-------- ---------- ---------- -----------
Comprehensive income ............................. $ 44,906 $1,075,029 $2,170,314 $ 2,734,913
======== ========== ========== ===========
5. ADVERTISING AND MARKETING COSTS
Currently, substantially all of the Company's advertising and marketing
costs are comprised of (1) costs associated with the transmission of e-mail
marketing messages, both from internal sources and external third party vendors,
(2) costs associated with the purchase of on-line consumer data, and (3) email
program promotional and creative development costs. Such costs are charged to
operations (1) at the time of the email transmission, (2) upon receipt of the
qualified consumer data, and (3) at the time the promotional and creative
services are provided, respectively, and are included as a component of cost of
sales.
In certain cases where the Company makes payment for consumer data, on-line
media, or prepays for commercial email delivery, in advance of the receipt or
provision of such items, the Company expenses such prepayments ratably over the
shorter of the contract period or to the extent of actual fulfillment. Total
advertising and marketing costs, included in the cost of sales, for the three
months ended August 31, 2002 and 2001 were approximately $3,127,000 and
$2,192,000, respectively, and for the nine months ended August 31, 2002 and 2001
were approximately $9,703,000 and $4,611,000, respectively.
Included in prepaid expenses and other current assets at August 31, 2002
and November 30, 2001, were approximately $43,000 and $324,000, respectively,
relating to the unamortized portion of prepayments related to marketing
arrangements.
10
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
6. MARKETABLE SECURITIES AND LONG-TERM INVESTMENTS, AT COST
During the three and nine months ended August 31, 2002, the Company did not
have any material events regarding its marketable securities or long-term,
cost-based investments.
During the three-month period ended February 28, 2001, the Company
recognized losses (through a permanent impairment charge) of $4,190,207 on
certain of its available-for-sale marketable securities. The underlying
securities' historical carrying values were reduced to their related closing
prices at February 28, 2001, giving effect to the prior year's permanent
impairment charge. The Company had continually evaluated the carrying value of
such investments, and in terms of risk at the individual company level coupled
with risk at the market level, the Company's prior year evaluation indicated
that the decline in the related securities was "other-than-temporary". As a
result of this analysis, the Company adjusted the "cost basis" of these
securities, effective February 28, 2001, to the closing prices on that date and
realized the corresponding loss during the three-month period ended February 28,
2001. This loss is included in the Company's other income (expense), "Permanent
impairment charges" for the nine months ended August 31, 2001.
During the fiscal year ended November 30, 2000, the Company had invested
approximately $500,000 in a private company, and carried the investment under
the cost method. After continued review of such investment, and the investment's
consistent failure to achieve significant goals set forth in its business and
financing plans, such investment fell within the Company's impairment evaluation
criteria. According to the above analysis, the Company's impairment loss for the
nine months ended August 31, 2001 amounted to $500,051, and is included as a
component of other income (expense) "Permanent impairment charges" for the nine
months ended August 31, 2001.
7. TALK AMERICA, INC. ARBITRATION AWARD
During the year ended November 30, 2001, the Company was successful in its
legal action against Talk America, Inc. ("Talk"), resulting in an approximate
$6.2 million arbitration award. The award represented restitution for long
distance customers delivered to Talk, and for lost profits suffered by the
Company due to Talk's wrongful termination of an agreement between the parties.
During the year ended November 30, 2001, the Company collected the first
installment of $3.7 million resulting from the arbitration award. The first
installment was included as revenue in the Company's fourth quarter of the
fiscal year ended November 30, 2001, as it was deemed to relate to the lost
profit portion of the arbitration settlement. During the nine months ended
August 31, 2002, the Company received the final installment, with interest, from
Talk in the sum of approximately $2.54 million. The final installment
represented approximately $227,000 in lost profits for long distance customers
delivered to Talk and, as such was included as revenue during the nine months
ended August 31, 2002. The balance of the second and final installment, or
approximately $2.3 million represented liquidated damages. The liquidated damage
portion of the final installment is included in the Company's "Other
income(expense)" income statement caption, and is grouped within that caption's
"Other non-operating income(expense)" sub-set. The balance of the second
installment, or $227,000, is included in the Company's revenues, with
approximately $158,000 included in the Company's E-commerce segment, and the
balance of approximately $70,000 included in the Company Off-line Marketing
Services segment.
8. SEGMENT INFORMATION
Historically, the Company's reportable operating segments are aligned into
three fundamental areas: (1) Internet Commerce billed directly to the Company's
marketing partners and corporate customers, as well as consumers (E-commerce),
(2) Off-line Marketing services (such as telemarketing and postal mail) billed
directly to long distance carriers, wireless carriers and other service
providing businesses (Off-line Marketing services) and (3) Products
11
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
and Services billed to consumers by Local Exchange Carriers (LEC Billed products
and services-inactive during the three and nine month periods ended August 31,
2002). The balance of the Company's operations, immaterial individually and in
the aggregate, are included as part of Corporate and other. This business
segment delineation is consistent with the Company's management and financial
reporting structure based on products and services. The Company evaluates
performance based on many factors, with the primary criteria being each
segment's gross profit and EBITDA, which the Company has defined as net income
excluding (i) special charges, (ii) interest expense, (iii) interest and
dividend income, (iv) net gains (losses) on the sale of marketable securities,
(v) long-lived asset impairment charges, (vi) gains on non-monetary cost basis
exchanges, (vii) other non-operating income, (viii) minority interest income
(loss), (ix) depreciation, (x) amortization and (xi) income taxes. The Company
shares a common workforce and office headquarters, which precludes an allocation
of all overhead components. Overhead items that are specifically identifiable to
a particular segment are applied to such segment and all other overhead costs
are included in Corporate and other. The following tables set forth the
Company's financial results, by management performance criteria, by operating
segment. All revenues are from non-intersegment sources; therefore no
intersegment elimination applies.
SEGMENT DATA -- NET REVENUE
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- --------------------------
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
2002 2001 2002 2001
------------ ------------ ----------- -----------
For the periods:
E-commerce .................................. $ 9,069,588 $7,203,452 $30,253,955 $16,834,124
Off-line Marketing Services ................. 1,594,658 -- 3,585,726 --
LEC Billed Products and Services ............ -- 201,368 -- 1,324,793
Corporate and other ......................... -- -- -- --
----------- ---------- ----------- -----------
CONSOLIDATED TOTALS ....................... $10,664,246 $7,404,820 $33,839,681 $18,158,917
=========== ========== =========== ===========
SEGMENT DATA -- GROSS PROFIT
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- --------------------------
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
2002 2001 2002 2001
------------ ------------ ----------- -----------
For the periods:
E-commerce .................................. $6,057,474 $4,965,555 $20,661,356 $12,111,583
Off-line Marketing Services ................. 1,388,612 41 3,198,350 (29,262)
LEC Billed Products and Services ............ -- 157,509 -- 1,169,279
Corporate and other ......................... -- -- -- --
---------- ---------- ----------- -----------
CONSOLIDATED TOTALS ....................... $7,446,086 $5,123,105 $23,859,706 $13,251,600
========== ========== =========== ===========
SEGMENT DATA -- EBITDA
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- --------------------------
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
2002 2001 2002 2001
------------ ------------ ----------- -----------
For the periods:
E-commerce .................................. $1,576,942 $2,798,129 $6,722,296 $5,920,916
Off-line Marketing Services ................. 261,973 (62,212) 553,654 (300,161)
LEC Billed Products and Services ............ -- 100,279 -- 934,260
Corporate and other ......................... (919,328) (1,199,295) (2,966,598) (2,761,370)
---------- ---------- ----------- -----------
CONSOLIDATED TOTALS ....................... $ 919,587 $1,636,901 $ 4,309,352 $ 3,793,645
========== ========== =========== ===========
12
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
SEGMENT DATA -- DEPRECIATION AND AMORTIZATION
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- --------------------------
AUGUST 31, AUGUST 31, AUGUST 31, AUGUST 31,
2002 2001 2002 2001
------------ ------------ ----------- -----------
For the periods:
E-commerce ................................... $249,107 $ 74,495 $587,649 $100,432
Off-line Marketing Services .................. 4,278 -- 15,265 --
LEC Billed Products and Services ............. -- -- -- --
Corporate and other .......................... 68,423 57,524 201,327 172,484
-------- --------- -------- --------
CONSOLIDATED TOTALS ........................ $321,808 $132,019 $804,241 $272,916
======== ========= ======== ========
9. ASSET ACQUISITIONS
In December 2001, the Company acquired the assets of the following two
entities for a total cost of $1,676,682. The components of the asset purchase
prices are set forth following the descriptions of the assets acquired:
o InfiKnowledge, a software development and Internet services firm based
in New Brunswick, Canada, with the key assets purchased including an
email delivery system, a suite of over 50 on-line games, as well as a
team of highly skilled, interactive game developers who, the Company
believes, possess the capabilities to enhance, develop and add support
to its on-line marketing business and provide the foundational assets to
allow the Company to internalize its email delivery platform through
capital expenditures, thereby reducing its reliance on third party email
delivery vendors.
o ThanksMuch, a Woodmere, New York based company that specializes in the
on-line sale of costume jewelry and other small gift items. The Company
anticipates that the assets acquired, coupled with the management team
who will continue to run the business, will be utilized to provide an
opportunity for increased revenue, gross profits and cash flows in
future fiscal periods.
The total purchase price for these two acquisition was: (a) cash of
$897,500, of which $697,500 was paid simultaneous with the respective asset
acquisition closings in December 2001 and $200,000 of which is payable to the
sellers of Infiknowledge on December 6, 2002 and which is included as a
component of the Company's accrued expenses as at August 31, 2002; and (b)
117,521 shares of the Company's common stock, valued at $6.20 per share (the
average closing prices of the Company's stock for the period December 4 to
December 10, 2001), which accounted for the additional consideration in the
InfiKnowledge asset acquisition. Of the total share consideration, 39,174 of
such shares were issued at the closing of the InfiKnowledge acquisition and
78,347 shares remain issuable, with 39,174 shares to be issued on December 6,
2002 and 39,173 shares to be issued on December 6, 2003. The issuable shares
were considered as outstanding common shares in the computation of both basic
and diluted weighted shares outstanding for the period December 6, 2001 to
August 31, 2002. Goodwill and other intangible assets recognized in the
transactions amounted to $1,477,000, of which approximately 90%, or $1.3
million, is expected to be deductible for income tax purposes. The goodwill and
other intangibles were assigned to the E-commerce segment. The purchase price
allocation has yet to be finalized pending the review of certain items regarding
identifiable intangibles and goodwill. It is estimated that this review will be
completed in the Company's fourth quarter ending November 30, 2002 and such
final allocation is anticipated to have an immaterial impact, if any, on
amortization expense.
13
TRAFFIX, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
10. LITIGATION
1. NANCY GAREN-- On or about October 16, 2001, Nancy Garen, author of
"Tarot Made Easy", commenced an action against a series of defendants, including
the Company, in the United States District Court for the Central District of
California, entitled NANCY GAREN V. STEVEN L. FEDER, PETER L. STOLZ, THOMAS H.
LINDSEY, GALACTIC TELCOM, INC., ACCESS RESOURCE SERVICES, INC., PSYCHIC READERS
NETWORK, INC. D/B/A MISS CLEO, OSHUN 5 COMMUNICATIONS, INC., CIRCLE OF LIGHT,
INC., CENTRAL TALK MANAGEMENT, INC., TRAFFIX, INC., WEKARE READERS &
INTERPRETERS, INC., WEST CORPORATION, AND DOES 1 THROUGH 10 (EDCV 01-790
(VAP-SGLx)). Plaintiff alleges that defendants are liable for a copyright
infringement, contributory copyright infringement, vicarious copyright
infringement, unfair competition, contributory federal unfair competition and
state statutory and common law unfair competition, and further requests a
constructive trust, a temporary restraining order, and damages from alleged
infringement of a copyright or, alternatively, statutory damages for each act of
infringement in "an amount provided by law in excess of $250,000,000", all as
the same may have arisen from the defendants' marketing of tarot card reading
and other psychic services. The Company does not believe that there is any merit
to Ms. Garen's claims as they relate to the Company, has denied the claims in
its answer to the complaint, and intends vigorously to defend against the
claims.
2. MAVIES WINGLER -- On or about May 9, 2001, Mavies Wingler commenced an
action against Group Lotto, Inc. ("GLI"), a wholly-owned subsidiary of the
Company, in the Circuit Court of Logan County, West Virginia. Ms. Wingler claims
to have picked the winning numbers entitling her to $10 million. On June 8,
2001, the action was removed to the United States District Court, Southern
District of West Virginia, and is entitled Wingler v. GroupLotto, Inc., Docket
Number 2:01 -- CV -- 518. The action is in the discovery stage. The Company does
noT believe that there is any merit to Ms. Wingler's claim, and intends
vigorously to defend against it. The Company and GLI have a contract of
indemnification with SCA Promotions, Inc. to be indemnified for prizes paid out
to qualified winners. GLI winners are required to produce the Group Lotto Entry
Notification form ("GLEN") within a specified period of time after matching a
drawing's winning numbers in order to qualify for receipt of the appropriate
prize winnings.
3. DANIEL RODGERS -- In March, 2002, Daniel Rodgers commenced an action
against the Company in Supreme Court of the State of New York, Rockland County.
The complaint alleges that the Company disseminated false and misleading
advertisements through email advertisements and through the website of its
subsidiary, GroupLotto.com. Mr. Rodgers purports to represent a class consisting
of those who, during the period January 1, 2001 to March 5, 2002, provided their
name, address, email address and other biographical information in response to
the email advertisements or in response to the GroupLotto web page. The
Complaint purports to allege claims of common law fraud, deceptive acts and
practices, and false and misleading advertising under New York law. The
Complaint seeks injunctive relief, unspecified monetary damages, and attorney's
fees. The Company believes that there is no merit to the claims, has filed a
motion to dismiss the complaint, which motion is pending before the court, and
otherwise intends vigorously to defend against the claims.
11. SUBSEQUENT EVENTS
On June 3, 2002, the American Arbitration Association rendered an award in
the sum of approximately $2.3 million (inclusive of interest) in favor of the
Claimants, in the arbitration entitled PHILIP MICHAEL THOMAS, PMT PRODUCTIONS
INC., KAYE PORTER MANAGEMENT, RMI ENTERTAINMENT, INC., MILLENNIUM TELEMEDIA,
INC., CLAIMANTS V. NEW LAUDERDALE, LLC D/B/A CALLING CARD CO., PSYCHIC READERS
NETWORK, INC. D/B/A PRN TELECOMMUNICATIONS, AND QUINTEL ENTERTAINMENT, INC.,
RESPONDENTS (NO. 131400004900). The award consists of approximately $1.48
million in damages, plus interest at nine percent (9%) from January 1, 1996 and
January 1, 1997, or approximately $785,000. The award also denied Claimants'
punitive damages and all other claims asserted in the arbitration.
14
The Claimants in the arbitration then filed a motion in an action pending
in the Circuit Court, Broward County, Florida (Thomas et al v. New Lauderdale,
LLC et al, Case No. 98-12259-07) (the "Action"), to confirm the award, and also
sought to be relieved from a stay of those proceedings in order to pursue claims
against the defendants in the Action which they contend have not been resolved
by the arbitration, including claims for punitive damages against the Company as
well as the individual defendants. The Respondents in the arbitration have filed
a motion to vacate and/or modify the award. The Company has indemnified the
individual defendants in the Action.
In order to avoid the uncertainties of further litigation and the
possibility of further awards in the Action, the Company agreed settle the
claims in the Action for approximately $435,000 and to pay the arbitration award
in exchange for full releases from the claimants. In September 2002, the
combined total of $2,710,000 representing the Arbitration Award, plus interest,
and the settlement was disbursed to the claimants.
The Company had accrued and recorded the total September 2002 payment as a
non-operating expense at August 31, 2002, and for the nine months ended August
31, 2002, as it results from a segment of the Company's business in which it is
no longer active.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The matters discussed in the following Management's Discussion and Analysis
of Financial Condition and Results of Operations may contain forward-looking
statements and information relating to the Company that are based on the current
beliefs and expectations of Management, as well as assumptions made by and
information currently available to the Company. When used in this Management's
Discussion and Analysis, and elsewhere in this Form 10-Q, the words
"anticipate", "believe", "estimate", and "expect" and similar expressions, as
they relate to the Company are intended to identify forward-looking statements.
Such statements reflect the current views of the Company's management, with
respect to future events and are subject to certain risks, uncertainties and
assumptions, which could cause the actual results to differ materially from
those reflected in the forward-looking statements.
OVERVIEW
We are a leading on-line database marketing company that acquires customers
for, drives consumer traffic to, and generates sales for our corporate clients.
We provide complete end-to-end marketing solutions for companies seeking to
increase sales and customers through on-line marketing programs, and database
development and enhancement programs. The services we offer range from the
development of a complete creative promotion to be used to market the client's
product to consumers, broadcasting the promotion on-line in order to generate
new customers for the client, delivery of data files from the results of
campaigns, creating and hosting the customized websites or web pages necessary
to effect the consumer transaction that drives the clients' sales and generating
comprehensive reporting in order for the client to analyze the effectiveness of
the promotion. We use the proprietary on-line media of our websites, interactive
games, email marketing and database of permission-based, profiled records to
generate the customers, sales and/or leads for our clients. We are paid by our
clients primarily on a success-based model, in that we receive a fee for every
lead, customer or sale generated for the client. In addition to our third party
client-based revenue, during fiscal 2002 we began generating revenue from our
proprietary products and services (e.g., costume jewelry and inexpensive gift
items) and from the sales and rentals (for use both on-line and off-line) of our
proprietary, profiled databases.
BACKGROUND
From our inception in 1993 (under the name "Quintel Communications, Inc.")
through 1999, we generated the bulk of our revenue from database marketing using
the traditional media of television, postal mail and telemarketing. In 2000, we
repositioned our database marketing business to the on-line media of the Web.
Applying the direct marketing disciplines honed from our years of operating in
the "off-line" media, our management believes it is able to provide
significantly enhanced response-based results in a more cost-efficient and
scaleable manner via on-line marketing. In addition, as a result of our direct
marketing background, we believe we are able to design on-line marketing
programs to cost-effectively generate traffic and leads for traditional direct
marketing media channels, such as inbound and outbound telemarketing and direct
mail.
15
ON-LINE MARKETING
We own the free on-line lottery, www.grouplotto.com, and other on-line
properties such as AtlasCreditGroup.com, AtlasEducationGroup.com, as well as a
number of interactive games (such as Direct Deposit Promotions and Scratch&Win),
vertical web sites and services on the Web. These properties are designed to
generate real-time response-based marketing. Consumers are given the
opportunity, while on-line, to purchase, sign-up for, ask to be contacted
regarding, or simply indicate an interest in, hundreds of offers for various
products and services provided by our corporate clients and marketing partners.
Specifically through these interactive Web properties we generate a variety of
transactional results for our corporate clients ranging from (a) Web traffic,
(b) inbound telemarketing calls, (c) outbound telemarketing leads, (d)
demographically/psychographically profiled lists of consumers, (e)
highly-targeted customized response-based leads, (f) completed applications for
products, and (g) actual sales of products and services.
GROUPLOTTO.COM. The GroupLotto website offers consumers the opportunity to
win up to $10 million daily in a free, on-line lottery. The lottery prizes are
indemnified by an independent, third-party agency. In order to play, each
consumer must provide complete and accurate registration information and agree
to receive ("opt-in") marketing messages from GroupLotto and our marketing
partners. The interactive media on this website includes registration pages,
game banners, and "pop-ups", the purpose of which is to generate web traffic,
leads and sales. Revenue is generated at this website from our corporate clients
who pay for such traffic, leads and sales. We generate our bulk consumer traffic
to this website through email marketing to lists of consumers who have indicated
an interest in our marketing programs by opting in to receive such offers.
Similar to the GroupLotto website, we generate results for our clients
through several other interactive games and products. For example, we market
through a "scratch and win" game that offers consumers the chance to instantly
find out if they have won any number of prizes. The consumer plays the game by
"scratching" with the mouse certain parts of the entry ticket to uncover the
results. These games can also be "pushed" to consumers by delivering them to the
player's email inbox. We also market credit card offers through our "Direct
Deposit" sweepstakes game (patent pending), whereby a consumer can win up to
$5,000 instantly if his or her credit card number matches a pre-selected winning
number.
We own and operate several other websites such as AtlasCreditGroup.com,
AtlasEducationGroup.com, prizecade.com, jewelclaimcenter.com and
games-to-win.com. We use these sites to generate revenue from our clients in a
similar manner as the GroupLotto model. We believe these sites could also offer
other new revenue opportunities, such as brand marketing. For the three months
ended August 31, 2002, these sites contributed approximately $745,000, or 7% of
the Company's net revenue during such period.
EMAIL MARKETING. Direct marketing via email remains one of our most
important revenue sources accounting for 42% and 53% of the Company's revenue in
the three and nine-month periods ended August 31, 2002, respectively. Each
program that we market for our clients can be implemented not only through the
website, interactive games and "pop-ups" discussed above, but also, and often
primarily, through email marketing. We currently market to as many as 100
million permission-based records, which are under management, or which have been
acquired by the Company under a number of affinity group based brands.
Compared to postal marketing and telemarketing, email marketing is
significantly less expensive, offers much faster response times, and, we
believe, provides for a more rich consumer media experience. We now own an email
delivery system, which reduces our dependence on third party vendors and further
reduces the expenses associated with delivering our monthly commercial email
messages. FOR A FURTHER DISCUSSION OF RECENT BUSINESS AND LEGAL DEVELOPMENTS
REGARDING THIS E-COMMERCE COMPONENT AND EVENTS IMPACTING EMAIL MARKETING, SEE
"-- RESULTS OF OPERATIONS."
One of the attractive features for clients, and, we believe, a significant
competitive advantage, is our ability to create and test a variety of marketing
campaigns for prospective and existing corporate clients at no risk to
16
the client. Since we own, and have access to, extensive databases, manage a
creative department, and can deliver email at a low cost, we are able to offer
prospective and existing clients the opportunity to test market new products,
services, price points and creative concepts in order to determine if an on-line
campaign works for the client and which campaigns work most effectively.
Even after campaigns are fully implemented, we further analyze the
marketing results to gauge whether the campaigns are continuing to generate
adequate results for the client, whether the media is being utilized
cost-efficiently, and to determine whether new and different copy is yielding
better overall results. These are the traditional direct-marketing disciplines,
which we believe, when applied together with our proprietary databases, and
other databases at our disposal, delivery systems and reporting systems,
distinguish us from our competitors in the on-line marketing industry.
SYNDICATION. After we develop a campaign that works efficiently on our
proprietary media, we often "syndicate" the program to third-party media.
Typically, we have expended time, media and other costs in developing certain
campaigns. In exchange for this invested effort, we obtain the right to market
those campaigns to a list of other on-line media companies. We enter into
agreements with these other on-line media companies to run the campaigns
generally on a fee-share arrangement. We believe these media companies benefit
by receiving an immediately marketable, fully-packaged and tested marketing
program. As a result, we believe we are able to leverage campaigns we have
developed (including our proprietary products and services) so that we can
generate additional revenue with virtually no costs or risks associated with
such business extension.
PROPRIETARY PRODUCTS AND SERVICES
A new business unit, which we introduced during the three months ended
February 28, 2002, is the on-line marketing of our own products and services.
For example, one of our websites, Thanksmuch.com, sells gift items (such as
DVD's, CD's and inexpensive jewelry) directly to consumers. When a consumer
selects a gift item and tenders his credit card, he is given the opportunity to
purchase other, more valuable products and services at special discounts. In
addition to the Thanksmuch line of jewelry and gifts, we are developing and
testing other products and services for direct marketing to consumers. These
products include credit card billed recurring products in the "Voice Over
Internet Protocol" area, dial-up modem ISP back-up systems, dating/personal
programs conducted over the Internet, jewelry, voicemail, dvd's and books. One
of the additional benefits of these programs is the ability of the Company to
accumulate permission-based consumer credit card data, which allows for the
subsequent use of the Company's marketing concept of "just-one-click" credit
card billing, making on-line purchases easier for the consumer, and allowing the
Company to more easily process additional sales and services in the future.
No assurances can be given, however, that these anticipated sources of
revenue will generate any significant income to our operations in future fiscal
periods, if at all. During the three months ended August 31, 2002, the
Thanksmuch.com website generated approximately $351,000, or approximately 3% of
net revenue, with an approximate $60,000 contribution to income from operations
from such revenue.
Our expansion in, and dependence on, our on-line direct marketing efforts,
coupled with the continued unproven reliability and profitability of such
efforts, the potential for state and/or federal legislation limiting on-line
marketing's consumer contact capability, and the potential for seasonality
within the E-commerce marketplace, should all be considered when referring to
our current three and nine month results, as well as prior historical results,
in evaluating the potential for our future operations, cash flows, and financial
position.
BASIS OF PRESENTATION
Certain amounts for the prior period that are presented in the accompanying
unaudited consolidated financial statements, and referred to in the discussions
below, have been reclassified to conform with the current period presentation.
17
SEGMENT INFORMATION
Segments are defined as components of an enterprise for which separate
financial information is available that is evaluated regularly by the chief
operating decision maker(s) in deciding how to allocate resources and in
assessing performance. Disclosure is also required about products and services,
geographic areas and major customers.
During the three and nine month periods ended August 31, 2002 and 2001, we
generated revenue from the following segments: E-Commerce, Off-line Marketing
and for fiscal 2001 only, LEC Billed Products. The E-Commerce segment realized
significant growth during the nine months ended August 31, 2002 and the fiscal
year ended November 30, 2001, when compared to the prior comparable periods, and
currently represents the core of our business operations. Revenue in the
E-commerce segment is generated primarily from marketing of third party products
and services on our websites and through e-mail promotions. The Off-Line
Marketing services segment consists of revenue generated by us through off-line
direct marketing channels. Historically, this segment's activities were
primarily telemarketing for the acquisition of long distance and wireless phone
customers for the respective carriers. Currently, this segment also includes
Montvale Management, LLC and its provision of net branch services to qualified
mortgage banking and lending institutions. The LEC Billed Products segment
represented telecommunications-related products and services marketed by us
directly to consumers who were billed by local exchange carriers on the
consumer's telephone bill. This segment was inactive during the nine months
ended August 31, 2002.
The Company evaluates performance based on many factors, with the primary
criteria being each segment's gross profit and EBITDA, which is net income
excluding (i) special charges, (ii) interest expense, (iii) interest and
dividend income, (iv) realized net (losses) gains on marketable securities, (v)
permanent impairment charges, (vi) gains on nonmonetary cost basis exchanges,
(vii) other nonoperating income (loss), (viii) minority interest income (loss),
(ix) depreciation, (x) amortization and (xi) income taxes. The Company shares a
common workforce and office headquarters, which precludes an allocation of all
overhead components. Overhead items that are specifically identifiable to a
particular segment are applied to such segment and all other overhead costs are
included in Corporate and other.
RESULTS OF OPERATIONS
The following is a discussion of the financial condition and results of
operations of the Company for the three and nine-month periods ended August 31,
2002 and August 31, 2001, respectively. It should be read in conjunction with
the Company's Form 10-K as filed for the year ended November 30, 2001, the Notes
thereto and other financial information included elsewhere in this report.
18
THREE MONTHS ENDED AUGUST 31, 2002 AND AUGUST 31, 2001
The Company's net revenues, on a segmental basis, and with disclosure of
the components of the individual segments, for each of the three month periods
ended August 31, 2002 and August 31, 2001, are detailed in the following tables:
SEGMENT DATA -- NET REVENUES, BY SEGMENT COMPONENT
THREE MONTHS ENDED
-------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ----------- ---------- --------
E-COMMERCE COMPONENTS
GroupLotto and other web sites .................. $ 3,375,023 $2,449,358 $ 925,665 38%
Net branch commission fees ...................... 281,411 -- 281,411 100%
Email marketing programs ........................ 4,526,228 4,335,949 190,279 4%
Data sales and rentals .......................... 485,154 418,145 67,009 16%
Sales of jewelry and gifts ...................... 351,290 -- 351,290 100%
Internet game development and other ............. 50,482 -- 50,482 100%
----------- ---------- ---------- -----
TOTAL E-COMMERCE ................................ 9,069,588 7,203,452 1,866,136 26%
----------- ---------- ---------- -----
OFF-LINE MARKETING SERVICE COMPONENTS
Net branch commission fees ...................... 1,594,658 -- 1,594,658 100%
Other off-line marketing ........................ -- -- --
----------- ---------- ---------- -----
TOTAL OFF-LINE MARKETING SERVICE ................ 1,594,658 -- 1,594,658 100%
----------- ---------- ---------- -----
LEC BILLED PRODUCTS AND SERVICES COMPONENTS
Enhanced Services, principally voice mail ....... -- 201,368 (201,368) -100%
----------- ---------- ---------- -----
TOTAL LEC BILLED PRODUCTS AND SERVICES .......... -- 201,368 (201,368) -100%
----------- ---------- ---------- -----
CORPORATE AND OTHER COMPONENTS
Miscellaneous products, list revenue and other .. -- -- -- 0%
----------- ---------- ---------- -----
TOTAL CONSOLIDATED NET REVENUE .................. $10,664,246 $7,404,820 $3,259,426 44%
=========== ========== ========== =====
Net Revenue increased $3,259,426, or 44%, to $10,664,246 for the three
months ended August 31, 2002 from $7,404,820 in the comparable prior year
period. The primary component of the increase was attributable to an approximate
$1.9 million increase in the Company's E-commerce segment net revenues, combined
with an increase of approximately $1.6 million in net revenue from the Company's
Off-line Marketing services segment. Such increases were partially offset by a
decrease of $201,368 in the Company's LEC Billed Product and Services legacy
segment. The E-commerce segment revenue increase resulted from the Company's
increasing focus on generating revenue from its current core business, on-line
direct marketing. The Company expects this segment to continue to represent the
substantial part of the Company's revenue in future fiscal periods.
Nevertheless, the Company continues to assess the potential of an increased
emphasis of revenue generation from off-line, conventional direct marketing
activities and will implement the strategy, beyond the bounds of Montvale
Management, LLC (see below), if deemed beneficial for the Company.
Additionally, the Company is using its on-line databases to enhance third
party off-line databases through the application of overlay technology, whereby
the Company's databases are appended to the databases of third parties,
effectively increasing the depth of consumer related information within the
appended database.
The growth in the Company's E-commerce segment was primarily attributable
to approximately $3.4 million in revenue generated from the segment's
"GroupLotto and other web site" sub-set. This represented an approximate
$926,000 increase over the prior year's $2.4 million in revenue generated from
such segment's sub-set. This increase of approximately 38% over the prior year's
comparable period was the result of the Company's use of its websites to acquire
a portion of the subscribers for one of the Company's customers. The Company did
not conduct business
19
with such customer during the comparable three months ended August 31, 2001.
Such customer accounted for approximately 25% of the Company's nine month August
31, 2002 revenue. The Company has been notified by the customer that it will
exercise its right to terminate its agreement with the Company, and, as such,
will phase out its business relationship with the Company over a ninety day
period ending December 7, 2002. This customer loss has been deemed immaterial at
the Company's operations level due to the fact that the operating margin earned
from such activity was less than that recognized from the Company's other
marketing activities and the Company believes that it will be able to use its
media channels, creative department and senior management's time, all of which,
it believes, was disproportionately dedicated to this customer, more profitably
by generating additional sales for other current customers with large demands,
improving results of existing customer relationships and developing new
relationships and proprietary products and services. The Company expects an
immaterial decline in future fiscal period revenues related to such termination,
and looks to realize improved margins at both the contribution and operating
level. Pursuant to the terms of the Company's agreement with this terminating
customer, during the 90-day phase out period, the customer is only required to
accept certain levels of sales generated by the Company on its behalf, based on
a percentage of sales recorded in the thirty day period prior to the delivery of
the termination notice. Therefore, the Company will recognize revenue under this
terminated agreement during the quarter ending November 30, 2002.
The Company generates a significant portion of its site traffic from email
marketing. SEE THE FOLLOWING PARAGRAPHS FOR A FURTHER DISCUSSION OF RECENT
BUSINESS AND LEGAL DEVELOPMENTS AFFECTING EMAIL MARKETING.
Additional increases in the Company's consolidated revenues are
attributable to new sub-sets added to the E-commerce segment during the three
months ended August 31, 2002 when compared to the three months ended August 31,
2001. The combined revenue resulting from the new sub-sets amounted to $683,183
and is detailed as follows: (a) $281,411 of such increase relates to the
Company's majority-owned subsidiary, Montvale Management LLC, that provides
services under a net branch agreement with licensed mortgage banking and
brokerage companies in the acquisition of candidates for new mortgages and the
refinancing of existing debt, which subsidiary also conducts the same services
off-line and is the sole component of the Company's Off-line Marketing Services
segment revenue of $1,594,658; (b) $351,290 of such increase relates to the
on-line sales of jewelry and gifts by the Company's subsidiary, ThanksMuch,
Inc., which was formed with the assets acquired from a closely held private
company on December 14, 2001, all as more fully described in Note 8 to the
financial statements; and (c) $50,482 of such increase relates to the Internet
game development revenues generated by the Company's subsidiary, InfiKnowledge
ULC, which was formed with the assets acquired from a closely held private
Canadian company on December 6, 2001, all as more fully described in Note 8 to
the financial statements.
The Company's E-Commerce Email Marketing sub-set revenues increased
$190,279, or 4%, to $4,526,228, during the three months ended August 31, 2002,
when compared to $4,335,949 during the prior year's comparable period. See the
following paragraph for a description of items impacting the Company's Email
Marketing programs.
During the three months ended May 31, 2002, the Company experienced
problems with the delivery of its email promotional offers, which problems have
continued into the three months ended August 31, 2002. Such problems reduced
revenue and income from the E-Commerce sub-segment on a sequential basis during
the first nine months of fiscal 2002. The Company continues to believe that the
significant component of the email delivery problem is attributable to Internet
Service Providers that unilaterally block commercial emails from reaching their
consumer subscribers. The Company has addressed the issue by deploying new
reinforced delivery platforms with increased redundancy and expanded
diversification using both internal and external emailing resources. The Company
has also increased the quality of data it is acquiring (at an increased cost)
and is simultaneously striving to eliminate poorly responding data from its
databases. The Company believes that over the long term, this improvement in
data quality, while more expensive, will yield greater stability and revenue
results and facilitate improved E-mail delivery results. Although the Company
has conceived of a number of programs to address this specific problem, there
can be no assurance that any of these programs will work effectively, or can be
timely implemented, and all such program implementations have had an immaterial
impact on improving the delivery rate of email during the three months ended
August 31, 2002.
20
Any further changes in the Internet operating landscape that materially
hinders the Company's current ability and/or cost to deliver commercial email
messages to the consumer records in its databases, and the consumer records in
the databases of its affiliates, could potentially cause a material impact on
net revenue and gross margin and, therefore, its profitability and cash flows
could be adversely affected. Various state laws exist, and federal legislation
is currently pending, that limit the Company's ability to deliver commercial
e-mail messages to consumers. There are presently no federal laws that regulate
sending unsolicited email. The pending federal bills and existing state laws
require that certain "opt-out" procedures be included in emails and prohibit
"false routing" or "fictitious address" information. Existing state, and pending
federal, laws require functioning return e-mail addresses and that valid postal
addresses be included by the senders of commercial email messages. Some states
require an "ADV" label in the subject line, and proscribe false header or
misleading subject lines. Attorneys General and/or consumers are given authority
to enforce the state laws. States with legislation affecting the sending of
unsolicited commercial email include: Arkansas, California, Colorado,
Connecticut, Delaware, Idaho, Illinois, Iowa, Louisiana, Maryland, Missouri,
Nevada, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South
Dakota, Tennessee, Utah, Virginia, Washington, West Virginia and Wisconsin. If
strict federal legislation is subsequently written into law, with its terms
specifically limiting the Company's ability to market its offers, the Company
could potentially realize a material adverse impact in future fiscal period net
revenue growth, and therefore, profitability and cash flows could be adversely
affected.
The increases in revenues from the Company's E-commerce segment and
Off-line Marketing Services segment were partially offset by a decrease of
$201,368 in revenues from the Company's LEC Billed Products and Services
segment. Such decrease resulted from the Company's elimination of billing voice
mail services under its contract with the service bureau known as Federal
Transtel, Inc. ("FTT") in October 2001. FTT has since filed for protection under
the United States Bankruptcy Code.
See "Transactions with Major Customers" and the Securities and Exchange
Commission's ("SEC") mandated FR-60 disclosures following the "Liquidity and
Capital Resources" section for a further discussion of the significant customer
concentrations, loss of significant customer, critical accounting policies and
estimates, and other factors that could affect future results.
The Company's cost of revenues during the three months ended August 31,
2002 and August 31, 2001 are comprised of direct and indirect marketing costs
associated with the (1) costs of email delivery, (2) acquisition of consumer
data, (3) premium fulfillment costs, (4) creative costs and (5) contingent-based
prize indemnification expense, billing and collection fees, and customer service
costs.
The Company's cost of sales, on a segmental basis, and with disclosure of
the components of the individual segments, for each of the three month periods
ended August 31, 2002 and August 31, 2001 are set forth below:
21
CONSOLIDATED COST OF SALES, BY SEGMENT, BY COMPONENT
FOR THE THREE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
E-COMMERCE
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Email marketing and related delivery costs ....... $1,164,606 $1,142,357 $ 22,249 2%
Data purchases and premium costs ................. 1,706,127 966,658 739,469 76%
Promotional, creative and other costs ............ 50,253 39,354 10,899 28%
---------- ---------- --------- -----
TOTAL E-COMMERCE ADVERTISING ................ $2,920,986 $2,148,369 $772,617 36%
---------- ---------- --------- -----
SERVICE BUREAU FEES
Contingent based prize indemnification costs ..... $ 91,128 $ 89,528 1,600 2%
---------- ---------- --------- -----
TOTAL E-COMMERCE COST OF SALES .............. $3,012,114 $2,237,897 $ 774,217 35%
---------- ---------- --------- -----
OFF-LINE MARKETING SERVICES
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Telemarketing, direct mail and related costs ..... $ 206,046 $ (41) $ 206,087 100%
---------- ---------- --------- -----
TOTAL OFF-LINE MARKETING COST OF SALES ...... $ 206,046 $ (41) $ 206,087 100%
---------- ---------- --------- -----
LEC BILLED PRODUCTS AND SERVICES
SERVICE BUREAU FEES
Billing and collection fees ...................... $ -- $ 43,859 $ (43,859) -100%
---------- ---------- --------- -----
TOTAL LEC BILLED COST OF SALES .............. $ -- $ 43,859 $ (43,859) -100%
---------- ---------- --------- -----
TOTAL COST OF SALES .................... $3,218,160 $2,281,715 $ 936,445 41%
---------- ---------- --------- -----
Cost of sales on a consolidated basis increased $936,445, or 41%, to
$3,218,160 for the three months ended August 31, 2002 from $2,281,715 in the
comparable prior year period.
On a segmental level, the Company's E-commerce segment cost of sales
increased, on a net basis, approximately $773,000, or 36%, to $2.9 million
during the three months ended August 31, 2002, when compared to $2.1 million
incurred in the prior year's comparable period. The Company's continuing
strategy of generating revenues primarily from direct marketing campaigns
delivered on-line was the significant factor contributing to this increase. The
Company realized marketing costs for email delivery of approximately $1.1
million in the fiscal quarters ended August 31, 2002 and August 31, 2001. This
apparently stable cost environment resulted from two offsetting factors. One
factor, which contributes to a decrease in email delivery cost, is the December
2001 acquisition of the assets of a Canadian-based technology company
(InfiKnowledge). The Company's integration of the acquired assets, technology
and human resources into its operations and email delivery platform has, and, we
believe, will continue to reduce the unitary costs of its email promotions and
serve to preserve and/or improve operating margins. The second factor, which
contributes to an offsetting increase in email delivery cost, relates to the
increased number of email messages sent on a comparable quarterly basis. This
increased email delivery volume generated approximately the same amount of email
marketing revenue on a comparable quarterly basis, detailed as follows: the
Company delivered email pieces in the three months ended August 31, 2002, which
were 6.5 times greater in volume than the volume of email pieces sent in the
prior year's three months ended August 31, 2001. As discussed in the net revenue
section, email revenue increased only 4% when compared to a 650% increase in
email pieces delivered. SEE THE PRECEDING "NET REVENUE" SECTION FOR A FURTHER
DISCUSSION OF RECENT BUSINESS AND LEGAL DEVELOPMENTS AFFECTING EMAIL MARKETING.
The Company realized costs of approximately $1.1 million for data
purchases necessary to build and maintain its marketing databases. In addition,
the Company realized costs of approximately $599,000 for premium costs related
to redemption obligations for certain of its marketing program offers. Together,
these costs represent an increase of approximately $739,000, or 76%, over
similar costs of $966,658 incurred during the three
22
months ended August 31, 2001. In the prior fiscal year's comparable period, the
Company had immaterial costs relative to premium redemption obligations. Within
the three and nine months ended August 31, 2002, the redemption obligations
arose primarily from operations performed on behalf of the customer that
terminated its relationship with the Company in September 2002, all as discussed
above. The Company anticipates that it will recognize improved margins in future
fiscal quarters due to the absence of fulfillment costs associated with the
termination of this customer relationship. See "Transactions with Major
Customers" and the Securities and Exchange Commission's ("SEC") mandated FR-60
disclosures following the "Liquidity and Capital Resources" section for a
further discussion of the significant customer concentrations, loss of
significant customer, critical accounting policies and estimates, and other
factors that could affect future results.
The Company uses the services of an agency for the provision of
indemnification coverage in the event the GroupLotto site produces a winner in
one of its free on-line lottery games. The costs attributable to the provision
of such indemnification coverage increased approximately $1,600, or 2%, when
compared with the fiscal period ended August 31, 2001. The indemnification cost
and players visiting the site remained relatively constant at the GroupLotto.com
website during the three months ended August 31, 2002 and 2001.
The Company's Off-line Marketing Services segment's cost of sales increased
$206,087, or 100%, when compared to $-0- during the three months ended August
31, 2001. The increase was attributable to the Company's majority-owned
subsidiary (Montvale Management LLC), which was inactive during the three months
ended August 31, 2001.
The balance of the decreases in cost of goods sold, offsetting the net
increase, relate to the LEC Billed Product and Service segment and amounted to a
reduction of $43,859. This reduction resulted from the Company's elimination of
billing voice mail services under its contract with the service bureau Federal
Transtel, Inc. ("FTT") in October 2001. FTT has since filed for protection under
the United States Bankruptcy Code.
The Company's gross profit in terms of dollars, on a segmental basis, and
the Company's gross profit percentage, on a segmental basis, for each of the
three month periods ended August 31, 2002 and 2001 are set forth below:
CONSOLIDATED GROSS PROFIT, BY SEGMENT
FOR THE PERIODS:
THREE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
E-commerce .................................... $6,057,473 $4,965,555 $1,091,918 22%
Off-line Marketing services ................... 1,388,613 41 1,388,572 100%
LEC Billed products and services .............. -- 157,509 (157,509) -100%
---------- ---------- ---------- -----
CONSOLIDATED TOTALS .................... $7,446,086 $5,123,105 $2,322,981 45%
========== ========== ========== =====
CONSOLIDATED GROSS PROFIT PERCENTAGES, BY SEGMENT
FOR THE PERIODS:
THREE MONTHS ENDED ABSOLUTE RELATIVE
------------------------- PERCENTAGE PERCENTAGE
AUGUST 31, AUGUST 31, CHANGE CHANGE
2002 2001 INC (DEC) INC (DEC)
----------- ---------- ---------- ----------
E-commerce .................................... 66.8% 68.9% -2.1% -3.1%
Customer Acquisition services ................. 87.1% 0.0% 87.1% 100.0%
LEC Billed products and services .............. 0.0% 78.2% -78.2% -100.0%
---- ---- ----- ------
CONSOLIDATED GROSS PROFIT PERCENTAGE ... 69.8% 69.2% 0.6% 0.9%
==== ==== ===== ======
23
Consolidated Gross Profit Percentage ("Gross Margin") as a percentage of
net revenue was 69.8% during the three months ended August 31, 2002, compared to
69.2% in the prior year's comparable fiscal period, representing an absolute
percentage point increase of less than 1%, or a 1% increase on a relative basis.
On a segmental basis, the Company's E-commerce segment recognized a decrease in
gross margin when compared to the prior year's comparable fiscal period. The
2.1% absolute percentage point decrease resulted from the Company's increased
costs associated with data purchases, which are fully expensed at the time of
the data's receipt. The Company anticipates that this expensing policy could
provide a margin improvement benefit in future fiscal periods through the
continued marketing to such acquired data. An additional factor offsetting the
net increase in the gross profit margin percentage is attributable to the costs
of fulfillment obligations related to the Company's marketing program conducted
for a long distance service provider, which terminated its contractual
relationship with the Company. SEE THE "NET REVENUE" DISCUSSION, SUPRA, FOR
ADDITIONAL INFORMATION ABOUT SUCH CUSTOMER. Such costs approximated $599,000 in
the current quarter ended August 31, 2002. During the prior year's comparable
period, the Company did not have a marketing program that generated significant
fulfillment costs. Increase in the gross margins generated from the Company's
Off-line Marketing Services segment more than offset decreases in the LEC
Product and Services segment, and accounted for the net increase in gross margin
percentage. See the previous discussions of net revenues and cost of sales for a
detailed discussion of such segments.
The Company's Selling Expenses for each of the three months ended August
31, 2002 and August 31, 2001 are presented, on a segmental basis, and with the
components of the individual segments, in the tables set forth below:
FOR THE PERIODS:
THREE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
E-COMMERCE
Fee share commissions ........................... $1,571,906 $293,609 $1,278,297 435%
Other commissions ............................... 453,117 -- 453,117 100%
Selling salaries and related expenses ........... 421,722 284,679 137,043 48%
Occupancy and equipment costs ................... 11,000 7,692 3,308 43%
Travel and entertainment ........................ 41,753 77,569 (35,816) -46%
---------- -------- ---------- ---
TOTAL SELLING-- E-COMMERCE SEGMENT ......... $2,499,498 $663,549 $1,835,949 277%
---------- -------- ---------- ---
OFF-LINE MARKETING SERVICES
Fee share commissions ........................... $ -- $ -- -- 0%
Other commissions ............................... -- -- -- 0%
Selling salaries and related expenses ........... 575,751 -- 575,751 100%
Occupancy and equipment costs ................... 51,635 -- 51,635 100%
Travel and entertainment ........................ 6,798 -- 6,798 100%
---------- -------- ---------- ---
TOTAL SELLING-- OFF-LINE SEGMENT ........... $ 634,184 $ 0 $ 634,184 100%
---------- -------- ---------- ---
CONSOLIDATED TOTALS ................... $3,133,682 $663,549 $2,470,133 372%
========== ======== ========== ===
Selling expenses on a consolidated basis increased approximately $2.5
million, or 372%, from $663,549 during the three months ended August 31, 2001 to
$3,133,682 during the three months ended August 31, 2002. The increase was
primarily attributable to the Company's E-commerce segment, with an increase of
approximately $1.8 million, and increases of $634,184 in selling expenses in the
Company's Off-line Marketing Services segment.
The significant factors contributing to the increase in selling expenses
were (a) increased fee share commissions ($1,278,297) and other sales related
commissions ($453,117) incurred in the Company's E-commerce segment; and (b)
increased selling-based base compensation and salesmen commissions of $137,043,
arising from the expansion of the E-commerce segment's sales force and selling
activities.
24
Regarding the increase in fee share commissions, during the fiscal year
ended November 30, 2001, the Company significantly expanded the practice of
marketing promotional offers on behalf of its marketing clients ("Clients") to
third party databases on a fee share commission basis. The fee share commission
relationship generally arises after the Company concludes a contractual
arrangement with a Client pursuant to which the Company modifies or develops
the:(i) copy, (ii) offer form and (iii) promotional materials for the Client's
product or service. The Company then tests the promotion, and agrees to deliver
a minimum level of new customers, and/or targeted leads to the Client.
Simultaneously with the execution of these contractual arrangements, the Company
often obtains the rights from the Client to market its promotions to a list of
third parties with whom the Company has marketing relationships (the "Third
Parties"). The Company enters into contracts with each Third Party with whom it
intends to market Client promotions. The terms of these agreements generally
provide that the Third Party has the right to (i) approve the creative materials
for each promotion, (ii) approve the timing of each promotion's mailing, (iii)
terminate the contract on short notice, and (iv) reject any promotion for any
reason. Each agreement also restricts the Third Party from doing business with
the Client other than through the Company for the period of time covered by the
agreement, and sets forth the terms of the Third Party's compensation. Payments
are performance-based only and are either fixed fees paid for each customer or
lead, generated for the Client, or a revenue share that is a percentage of the
revenue generated (after deduction for certain direct costs) by the Company for
marketing that offer to the Third Party database. The Company utilizes unique
Universal Resource Locater identifier links ("URLs") when promotions are mailed
to the Third Party database. It is the unique URL's that form the tracking
mechanism by which the Client reports results to the Company, and the Company is
able to account for revenue generated under the fee share arrangement with Third
Parties. In addition, the Company manages Third Party databases on a revenue
share basis. Amounts payable to the Third Parties under these programs are
captured in the "fee share commission" category of selling expense.
Selling expenses within the Company's Off-line Marketing Services segment
increased $634,184, or 100%, when compared to the prior year's comparable
period. The Company expects that in the balance of the fiscal year ending
November 30, 2002 it will continue to realize increases in this segment's
selling expenses based on the anticipated expansion of the operations of its
majority owned subsidiary, Montvale Management LLC, which conducts business
off-line, as well as on-line, as a net branch for licensed mortgage banking and
brokerage companies.
The Company's general and administrative expenses ("G&A") are principally
comprised of (i) compensation costs and related expenses for executive, finance,
information systems and general administration personnel, (ii) professional fees
(which include legal; audit, accounting and tax; public relations; database
management and consulting; and public company related printing costs), (iii)
insurance costs, (iv) occupancy and other equipment rental costs, (v) site
development, maintenance and modification costs related to the Company's
E-commerce segment, and (vi) all other general and miscellaneous corporate
expense items.
25
CONSOLIDATED GENERAL AND ADMINISTRATIVE EXPENSES, BY SEGMENT, BY COMPONENT
FOR THE PERIODS:
THREE MONTHS ENDED
--------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
---------- ----------- --------- --------
E-COMMERCE
Compensation costs and related expenses .......... $1,147,353 $ 527,717 $ 619,636 117%
Professional fees ................................ 294,776 309,413 (14,637) -5%
Insurance costs .................................. 113,584 148,888 (35,304) -24%
Occupancy and equipment costs .................... 88,153 57,433 30,720 53%
Site development, maintenance and modifications .. 199,748 317,845 (118,097) -37%
All other G&A expenses ........................... 337,583 217,076 120,507 56%
---------- ---------- --------- -----
TOTAL G&A-- E-COMMERCE SEGMENT ................... $2,181,197 $1,578,372 $602,825 38%
---------- ---------- --------- -----
OFF-LINE MARKETING SERVICES
Compensation costs and related expenses .......... $ -- $ 36,758 $ (36,758) -100%
Professional fees ................................ 2,210 -- 2,210 100%
Insurance costs .................................. -- 8,499 (8,499) -100%
Occupancy and equipment costs .................... -- 7,179 (7,179) -100%
All other G&A expenses ........................... 494,523 9,817 484,706 4937%
---------- ---------- --------- -----
TOTAL G&A-- OFF-LINE SEGMENT ..................... $ 496,733 $ 62,253 $434,480 698%
---------- ---------- --------- -----
LEC BILLED PRODUCTS AND SERVICES
Compensation costs and related expenses .......... $ -- $ 36,602 $ (36,602) -100%
Insurance costs .................................. -- 8,499 (8,499) -100%
Occupancy and equipment costs .................... -- 7,179 (7,179) -100%
All other G&A expenses ........................... -- 4,950 (4,950) -100%
---------- ---------- --------- -----
TOTAL G&A-- LEC SEGMENT .......................... $ -- $ 57,230 $ (57,230) -100%
---------- ---------- --------- -----
CORPORATE AND OTHER
Compensation costs and related expenses .......... $ 522,763 $ 669,738 $(146,975) -22%
Professional fees ................................ 205,121 397,654 (192,533) -48%
Insurance costs .................................. 110,408 916 109,492 100%
All other G&A expenses ........................... 149,459 188,511 (39,052) -21%
---------- ---------- --------- -----
TOTAL G&A-- CORPORATE AND OTHER .................. $ 987,751 $1,256,819 $(269,068) -21%
---------- ---------- --------- -----
CONSOLIDATED TOTALS .............................. $3,665,681 $2,954,674 $ 711,007 24%
========== ========== ========= =====
General and Administrative expenses ("G&A") on a consolidated basis
increased approximately $711,000, or 24%, when comparing G&A of approximately
$2.9 million from the three months ended August 31, 2001 to G&A of approximately
$3.7 million incurred during the three months ended August 31, 2002. The net
increase was attributable to (a) the Company's E-commerce segment (approximately
$603,000, or 85% of the total increase), with such increase related to increased
compensation costs and other G&A expenses, offset by declines in professional
fees, insurance costs and maintenance costs associated with the Company's web
sites, all required to support the 26% increase in revenues generated by such
segment during the three months ended August 31, 2002; and by (b) increases
attributable to the Company's Off-line Marketing Services Segment (approximately
$434,000, or 61% of total increase), with such increase related to G&A necessary
to support the segment's growth in revenues from $ -0- in fiscal 2001's third
quarter to approximately $1.6 million during the three months ended August 31,
2002; with all the above increases being offset by a decrease in other corporate
overhead of approximately $269,000 in expense items not specifically
identifiable to the Company's operating segments, with such cost increase
including (i) directors and officers liability insurance, (ii) professional fees
incurred in the defense of actions arising from legacy operations, and (iii)
other non-allocable G&A expenses. An additional offset to the net G&A overhead
increase was an approximate $57,000 decrease in G&A overhead attributable to the
Company's currently inactive LEC Billed Product and Services segment.
26
OTHER INCOME (EXPENSE)
The Company's components of "Other income (expense)" for the three months
ended August 31, 2002 and 2001 are set forth below:
FOR THE PERIODS:
THREE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
Other income (expense):
Interest expense .................................. $ (7,865) $ -- $ (7,865) 100%
Interest income and dividends ..................... 190,805 353,645 (162,840) -46%
Realized gains (losses) on sale of
marketable securities .......................... 2,664 405,837 (403,173) -99%
Other non-operating income:
P.M.Thomas Arbitration Settlement .............. (434,418) (434,418) 100%
Residual revenues from terminated
Programs ..................................... -- (4,060) 4,060 -100%
Other miscellaneous income (expense) ........... (22,571) -- (22,571) 100%
Minority interest (income) loss ................... (148,782) -- (148,782) 100%
--------- --------- ----------- -----
TOTAL CONSOLIDATED OTHER INCOME (EXPENSE) ......... $(420,167) $ 755,422 $(1,175,589) -156%
========= ========= =========== =====
Consolidated Other Income (Expense) decreased approximately $1.2 million,
from income of approximately $755,000 for the three months ended August 31, 2001
to (expense) of approximately ($420,000) for the three months ended August 31,
2002.
The primary factors contributing to the net decrease, in the order of the
table set forth above, are as follows:
(a) a decrease in interest and dividend income of approximately $163,000
resulting from significant decreases in the interest rates available on
short-term commercial paper during the three months ended August 31, 2002 when
compared with interest rates available for short-term investment during the
three months ended August 31, 2001; and
(b) a decrease in gains realized through sales of marketable securities
approximating $403,000 in the quarter ended August 31, 2002, when compared to
the quarter ended August 31, 2001, which included gains of approximately
$406,000.
Additionally, the three months ended August 31, 2002, included the final
settlement liability of approximately $434,000 related to the Phillip Michael
Thomas arbitration.
PROVISION FOR INCOME TAXES
The Company's effective income tax rate is a result of the combination of
federal income taxes at statutory rates, and state taxes, subject to the effects
of valuation allowances taken against the "realizability" of deferred tax
assets. The Company recorded income tax expense of $69,235 for the three months
ended August 31, 2002 on pre-tax income of $177,615. This equates to an
effective tax rate of approximately 38.9%. This effective tax rate is less than
the Company's historically recognized tax rate due to the partial realization in
the three months ended August 31, 2002 of previously devalued deferred tax
assets related to capital losses, coupled with the effect of interim period tax
allocation. In the prior comparable period, the Company had recorded income tax
expense of $797,312 on a pre-tax profit of approximately $2,260,304. This
represented an effective tax rate of 35.3%.
Such prior quarter also benefited from the partial realization of
previously devalued deferred tax assets related to capital losses.
27
NINE MONTHS ENDED AUGUST 31, 2002 AND AUGUST 31, 2001
The Company's net revenues, on a segmental basis, and with disclosure of
the components of the individual segments, for each of the nine month periods
ended August 31, 2002 and August 31, 2001, are detailed in the following tables:
SEGMENT DATA -- NET REVENUES, BY SEGMENT COMPONENT
NINE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
E-COMMERCE COMPONENTS
GroupLotto and other web sites .................. $ 7,614,885 $ 4,941,285 $ 2,673,600 54%
Net branch commission fees ...................... 613,620 -- 613,620 100%
Email marketing programs ........................ 17,988,261 9,892,382 8,095,879 82%
Data sales and rentals .......................... 2,549,172 2,000,457 548,715 27%
Sales of jewelry and gifts ...................... 1,172,427 -- 1,172,427 100%
Internet game development and other ............. 315,590 -- 315,590 100%
----------- ----------- ----------- -----
TOTAL E-COMMERCE ................................ 30,253,955 16,834,124 13,419,831 80%
----------- ----------- ----------- -----
OFF-LINE MARKETING SERVICE COMPONENTS
Net branch commission fees ...................... 3,516,787 -- 3,516,787 100%
Other off-line marketing ........................ 68,939 -- 68,939 100%
----------- ----------- ----------- -----
TOTAL OFF-LINE MARKETING SERVICE ................ 3,585,726 -- 3,585,726 100%
----------- ----------- ----------- -----
LEC BILLED PRODUCTS AND SERVICES COMPONENTS
"900" Entertainment Service royalties ........... 486,406 (486,406) -100%
Enhanced Services, principally voice mail ....... -- 838,387 (838,387) -100%
----------- ----------- ----------- -----
TOTAL LEC BILLED PRODUCTS AND SERVICES .......... -- 1,324,793 (1,324,793) -100%
----------- ----------- ----------- -----
CORPORATE AND OTHER COMPONENTS
Miscellaneous products, list revenue and other .. -- -- 0%
----------- ----------- ----------- -----
TOTAL CONSOLIDATED NET REVENUE .................. $33,839,681 $18,158,917 $15,680,764 86%
=========== =========== =========== =====
Net Revenue increased $15,680,764, or 86%, to $33,839,681 for the nine
months ended August 31, 2002 from $18,158,917 in the comparable prior year
period. The primary component of the increase was attributable to an approximate
$13.4 million increase in the Company's E-commerce segment net revenues,
combined with an increase of approximately $3.6 million in net revenue from the
Company's Off-line Marketing services segment. Such increases were partially
offset by a decrease of $1.3 million in the Company's LEC Billed Product and
Services legacy segment. The E-commerce segment revenue increase resulted from
the Company's increasing focus on generating revenue from its current core
business, on-line direct marketing. The Company expects this segment to continue
to represent the substantial part of the Company's revenue in future fiscal
periods. Nevertheless, the Company continues to assess the potential of an
increased emphasis on revenue generation from off-line, conventional direct
marketing activities and will implement the strategy if deemed beneficial for
the Company. Currently, the Company is using its on-line databases to enhance
third party off-line databases through the application of overlay technology,
whereby databases are appended to one another, effectively increasing the depth
of consumer related information within the appended database.
The growth in the Company's E-commerce segment was primarily attributable
to approximately $18 million in revenue generated from the segment's E-mail
marketing program sub-set. This represented an $8.1 million increase over the
prior year's $9.9 million in revenue generated from such segment's sub-set. This
substantial increase of approximately 82% over the prior year's comparable
period was primarily the result of the Company's acquisition of significant
volumes of permission-based email records, extension of the quantity and quality
of third party (client) offers being emailed to the databases and greater
efficiencies in the Company's email delivery programs. In the prior year's
comparable period, specifically the first three months of the fiscal year ended
November
28
30, 2001, the Company had been in the early stages of developing and carrying
out its online strategy. The sub-set of E-mail marketing program revenue
represented approximately 53% of the Company's consolidated net revenue for the
nine months ended August 31, 2002.
During the nine months ended August 31, 2002, specifically within the
period March 1, 2002 to August 31, 2002, the Company experienced problems with
the delivery of its email promotional offers. Such problems reduced revenue and
income from the E-Commerce sub-segment. The Company continues to believe that
the significant component of the email delivery problem is attributable to
Internet Service Providers that unilaterally block commercial emails from
reaching their consumer subscribers. The Company has addressed the issue by
deploying new reinforced delivery platforms with increased redundancy and
expanded diversification using both internal and external emailing resources.
The Company has also increased the quality of data it is acquiring (at an
increased cost) and is simultaneously striving to eliminate poorly responding
data from its databases. The Company believes that over the long term, this
improvement in data quality, while more expensive, will yield greater stability
and revenue results and facilitate improved E-mail delivery results. Although
the Company has conceived of a number of programs to address this specific
problem, there can be no assurance that any of these programs will work
effectively, or can be timely implemented, and all such program implementations
have had an immaterial impact on improving the delivery rate of email during the
three months ended August 31, 2002.
Any further changes in the Internet operating landscape that materially
hinders the Company's current ability and/or cost to deliver commercial email
messages to the consumer records in its databases, and the consumer records in
the databases of its affiliates, could potentially cause a material impact on
net revenue and gross margin and, therefore, its profitability and cash flows
could be adversely affected. Various state laws exist, and federal legislation
is currently pending, that limit the Company's ability to deliver commercial
e-mail messages to consumers. There are presently no federal laws that regulate
sending unsolicited email. The pending federal bills and existing state laws
require that certain "opt-out" procedures be included in emails and prohibit
"false routing" or "fictitious address" information. Existing state, and pending
federal, laws require functioning return e-mail addresses and that valid postal
addresses be included by the senders of commercial email messages. Some states
require an "ADV" label in the subject line, and proscribe false header or
misleading subject lines. Attorneys General and/or consumers are given authority
to enforce the state laws. States with legislation affecting the sending of
unsolicited commercial email include: Arkansas, California, Colorado,
Connecticut, Delaware, Idaho, Illinois, Iowa, Louisiana, Maryland, Missouri,
Nevada, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South
Dakota, Tennessee, Utah, Virginia, Washington, West Virginia and Wisconsin. If
strict federal legislation is subsequently written into law, with its terms
specifically limiting the Company's ability to market its offers, the Company
could potentially realize a material adverse impact in future fiscal period net
revenue growth, and therefore, profitability and cash flows could be adversely
affected.
The Company's E-commerce segment's "GroupLotto and other web sites" sub-set
realized an increase in revenues of $2.7 million, or 54%, when comparing the
current nine months ended August 31, 2002 ($7.6 million in revenue) with the
nine months ended August 31, 2001 ($4.9 million in revenue). This increase is
the result of the Company's shift from low priced "click through" revenue to
higher revenue generating registration, lead generation and on-line customer
acquisition based revenue. The Company generates a significant portion of its
site traffic from email marketing. SEE THE PRECEDING PARAGRAPH FOR A FURTHER
DISCUSSION OF RECENT BUSINESS AND LEGAL DEVELOPMENTS EFFECTING EMAIL MARKETING.
Additional increases in the Company's consolidated revenues were
attributable to new sub-sets added to the E-commerce segment during the nine
months ended August 31, 2002 when compared to the nine months ended August 31,
2001. The combined revenue resulting from the new sub-sets amounted to
approximately $2.1 million and is detailed as follows; (a) $613,620 of such
increase relates to the Company's majority-owned subsidiary (Montvale Management
LLC) that provides services under a net branch agreement with licensed mortgage
banking and brokerage companies in the acquisition of candidates for new
mortgages and the refinancing of existing debt, which subsidiary also conducts
the same services off-line and recorded approximately $3.5 million within its
Off-line Marketing Services segment; (b) $1.2 million of such increase relates
to the on-line sales of jewelry and gifts by the Company's new subsidiary,
ThanksMuch, Inc., which was formed with the assets acquired from a closely held
private company on December 14, 2001, all as more fully described in Note 8 to
the financial statements;
29
(c) $215,590 of such increase relates to the Internet game development revenues
generated by the Company's new subsidiary, InfiKnowledge ULC, which was formed
with the assets acquired from a closely held private Canadian company on
December 6, 2001, all as more fully described in Note 8 to the financial
statements; and (d) the balance of such increase, or $100,000, was attributable
to a web marketing, design and development contract executed and completed by
the Company during the three months ended February 28, 2002.
The increases in revenues from the Company's E-commerce segment and
Off-line Marketing Services segment were partially offset by a decrease of
$1,324,793 in revenues from the Company's LEC Billed Products and Services
segment. A portion of the decrease, or $486,406, resulted from the expiration in
the prior year's three months ended February 28, 2001, of certain agreements
pursuant to which the Company had been paid a royalty fee (with virtually no
corresponding costs) to refrain from conducting, marketing, advertising or
promoting certain LEC Billed Products and Services. The nine months ended August
31, 2002, did not include any revenue related to these services and the Company
does not anticipate re-entering that market. The balance of the decrease in LEC
Billed Product and Service segment revenue, or $838,387, resulted from the
Company's elimination of billing voice mail services under its contract with the
service bureau Federal Transtel, Inc. ("FTT") in October 2001. FTT has since
filed for protection under the United States Bankruptcy Code.
See "Transactions with Major Customers" and the Securities and Exchange
Commission's ("SEC") mandated FR-60 disclosures following the "Liquidity and
Capital Resources" section for a further discussion of the significant customer
concentrations, loss of significant customer, critical accounting policies and
estimates, and other factors that could affect future results.
The Company's cost of revenues during the nine months ended August 31, 2002
and August 31, 2001 are comprised of (1) direct and indirect marketing costs
associated with the (a) contact and identification strategies, (b) procurement
and (c) retention of consumers for its databases, including direct response
email marketing costs, data purchases, promotional costs and premium fulfillment
costs, and (2) the related contingent-based prize indemnification expense, and
LEC segment related billing and collection fees, and customer service costs.
The Company's cost of sales, on a segmental basis, and with disclosure of
the components of the individual segments, for each of the nine month periods
ended August 31, 2002 and August 31, 2001 are set forth below:
CONSOLIDATED COST OF SALES, BY SEGMENT, BY COMPONENT
FOR THE NINE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
E-COMMERCE
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Email marketing and related delivery costs ...... $3,751,632 $2,269,214 $1,482,418 65%
Data purchases and premium costs ................ 5,429,576 2,067,665 3,361,911 163%
Promotional, creative and other costs ........... 134,872 89,508 45,364 51%
---------- ---------- ---------- -----
TOTAL E-COMMERCE ADVERTISING .................... $9,316,080 $4,426,387 $4,889,693 110%
---------- ---------- ---------- -----
SERVICE BUREAU FEES
Contingent based prize indemnification costs .... $ 276,519 $ 296,154 $ (19,635) -7%
---------- ---------- ---------- -----
TOTAL E-COMMERCE COST OF SALES .................. $9,592,599 $4,722,541 $4,870,058 103%
---------- ---------- ---------- -----
OFF-LINE MARKETING SERVICES
ADVERTISING, PROMOTION AND FULFILLMENT COSTS
Telemarketing, direct mail and related costs .... $ 387,376 $ 21,698 $ 365,678 100%
Premium fulfillment costs ....................... -- 7,564 (7,564) -100%
---------- ---------- ---------- -----
TOTAL OFF-LINE MARKETING COST OF SALES .......... $ 387,376 $ 29,262 $ 358,114 1224%
---------- ---------- ---------- -----
(CONTINUED ON NEXT PAGE)
30
(CONTINUED FROM PREVIOUS PAGE)
LEC BILLED PRODUCTS AND SERVICES
SERVICE BUREAU FEES
Billing and collection fees ...................... $ -- $ 155,514 $ (155,514) -100%
---------- ---------- ---------- -----
TOTAL LEC BILLED COST OF SALES ................... $ -- $ 155,514 $ (155,514) -100%
---------- ---------- ---------- -----
TOTAL COST OF SALES .............................. $9,979,975 $4,907,317 $5,072,658 103%
========== ========== ========== =====
Cost of sales on a consolidated basis increased $5,072,658, or 103%, to
$9,979,975 for the nine months ended August 31, 2002 from $4,907,317 in the
comparable prior year period.
On a segmental level, the Company's E-commerce segment cost of sales
increased, on a net basis, approximately $4.9 million, or 110%, to $9.3 million
during the nine months ended August 31, 2002, when compared to $4.4 million
incurred in the prior year's comparable period. The Company's continuing
strategy of generating revenues primarily from direct marketing campaigns
delivered on-line was the significant factor contributing to this increase. The
Company realized marketing costs for email delivery of approximately $3.7
million in the nine months ended August 31, 2002, representing an increase of
$1.5 million, or 65%, when compared to approximately $2.3 million in email
delivery costs incurred in the prior year's comparable period. In December 2001,
the Company acquired the assets of a Canadian-based technology company
(InfiKnowledge). The Company continues to believe and expect that the
integration of the acquired assets, technology and human resources into its
operations and email delivery platform will continue to reduce the unitary costs
of its email promotions and serve to preserve and/or improve operating margins.
SEE THE PRECEDING "NET REVENUE" SECTION FOR A FURTHER DISCUSSION OF RECENT
BUSINESS AND LEGAL DEVELOPMENTS ATTRIBUTABLE TO EMAIL MARKETING.
The Company realized costs of approximately $3.6 million for data purchases
necessary to build and maintain its marketing databases and approximately $1.8
million for premium costs related to premium redemption obligations for certain
of its marketing program offers. These costs represent an increase of
approximately $3.4 million, or 163%, over data purchase costs of $2.1 million
during the nine months ended August 31, 2001. In the prior fiscal year's
comparable period, the Company had immaterial costs relative to redemption
obligations.
The Company uses the services of an agency for the provision of
indemnification coverage in the event the GroupLotto site produces a winner in
one of its free on-line lottery games. The costs attributable to the provision
of such indemnification coverage decreased approximately $20,000, or 7%, when
compared with the prior fiscal period ended August 31, 2001. The reason for this
decrease was due to a slight decrease in the games played at the Company's
GroupLotto.com website during the nine months ended August 31, 2002 when
compared to the prior year's comparable period.
The Company's Off-line Marketing Services segment's cost of sales increased
$358,114, or 1224%, to $387,376, when compared to $29,262 during the nine months
ended August 31, 2001. The increase was attributable to the Company's
majority-owned-subsidiary (Montvale Management LLC), which was inactive during
the nine months ended August 31, 2001.
The balance of the decrease in cost of goods sold relates to the LEC Billed
Product and Service segment and amounted to a reduction of $155,514. This
reduction resulted from the Company's elimination of billing voice mail services
under its contract with the service bureau Federal Transtel, Inc. ("FTT") in
October 2001. FTT has since filed for protection under the United States
Bankruptcy Code.
The Company's gross profit in terms of dollars, on a segmental basis, and
the Company's gross profit percentage, on a segmental basis, for each of the
nine month periods ended August 31, 2002 and 2001 are set forth below:
31
CONSOLIDATED GROSS PROFIT, BY SEGMENT
FOR THE PERIODS:
NINE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
E-commerce ................................... $20,661,356 $12,111,583 $ 8,549,773 71%
Off-line Marketing services .................. 3,198,350 (29,262) 3,227,612 100%
LEC Billed products and services ............. -- 1,169,279 (1,169,279) -100%
----------- ----------- ----------- -----
CONSOLIDATED TOTALS ........................ $23,859,706 $13,251,600 $10,608,106 80%
=========== =========== =========== =====
CONSOLIDATED GROSS PROFIT PERCENTAGES, BY SEGMENT
FOR THE PERIODS:
NINE MONTHS ENDED ABSOLUTE RELATIVE
------------------------- PERCENTAGE PERCENTAGE
AUGUST 31, AUGUST 31, CHANGE CHANGE
2002 2001 INC (DEC) INC (DEC)
----------- ---------- ---------- ----------
E-commerce ................................... 68.3% 71.9% -3.7% -5.1%
Customer Acquisition services ................ 89.2% 0.0% 89.2% 100.0%
LEC Billed products and services ............. 0.0% 88.3% -88.3% -100.0%
---- ---- ----- ------
CONSOLIDATED GROSS PROFIT PERCENTAGE ....... 70.5% 73.0% -2.5% -3.4%
==== ==== ===== ======
Consolidated Gross Profit Percentage ("Gross Margin") as a percentage of
net revenue was 70.5% during the nine months ended August 31, 2002, compared to
73.0% in the prior year's comparable fiscal period, representing an absolute
percentage point decrease of 2.5%, or a 3.4% decline on a relative basis. On a
segmental basis, the Company's E-commerce segment accounted for the majority of
the decrease in margin when compared to the comparable prior fiscal period. The
3.7% absolute percentage point decrease resulted from the Company's increased
costs associated with data purchases, which are fully expensed at the time of
receipt. The Company anticipates that this expensing policy could provide a
margin improvement benefit in future fiscal periods through the continued
marketing to such acquired data. An additional factor contributing to the slight
decline in the gross margin percentage is attributable to the costs of
fulfillment obligations related to the Company's marketing program offers
conducted for a long distance service provider. Such costs approximated $1.8
million in the nine months ended August 31, 2002. During the prior year's
comparable period, the Company did not have a marketing program that generated
significant fulfillment costs. Changes in the gross margins generated from the
Company's Off-line Marketing Services segment and LEC Product and Services
segment primarily offset each other in terms of percentage changes. See the
previous discussions of net revenues and cost of sales in the three and nine
month sections for a more detailed discussion of such segments.
The Company's Selling Expenses and General and Administrative Expenses for
each of the nine months ended August 31, 2002 and August 31, 2001 are presented,
on a segmental basis, and with the components of the individual segments, in the
tables set forth below:
FOR THE PERIODS:
NINE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
E-COMMERCE
Fee share commissions ........................... $4,221,275 $ 703,244 $3,518,031 500%
Other commissions ............................... 1,407,222 -- 1,407,222 100%
Selling salaries and related expenses ........... 1,246,089 745,692 500,397 67%
Occupancy and equipment costs ................... 22,715 18,797 3,918 21%
Travel and entertainment ........................ 208,643 185,902 22,741 12%
---------- ---------- ---------- ----
TOTAL SELLING-- E-COMMERCE SEGMENT .............. $7,105,944 $1,653,635 $5,452,309 330%
---------- ---------- ---------- ----
(CONTINUED ON NEXT PAGE)
32
(CONTINUED FROM PREVIOUS PAGE)
OFF-LINE MARKETING SERVICES
Fee share commissions ............................ $ -- $ -- -- 0%
Other commissions ................................ -- -- -- 0%
Selling salaries and related expenses ............ 1,422,871 -- 1,422,871 100%
Occupancy and equipment costs .................... 97,524 -- 97,524 100%
Travel and entertainment ......................... 24,657 24,657 100%
---------- ---------- ---------- ----
TOTAL SELLING-- OFF-LINE SEGMENT ................. $1,545,052 $ -- $1,545,052 100%
---------- ---------- ---------- ----
CONSOLIDATED TOTALS .............................. $8,650,996 $1,653,635 $6,997,361 423%
========== ========== ========== ====
Selling expenses on a consolidated basis increased approximately $7
million, or 423%, from $1.7 million during the nine months ended August 31, 2001
to $8.6 million during the nine months ended August 31, 2002. The increase was
primarily attributable to the Company's E-commerce segment, with an increase of
approximately $5.5 million, and increases of approximately $1.5 million in
selling expenses in the Company's Off-line Marketing Services segment.
The significant factors contributing to the increase in selling expenses
were (a) increased fee share commissions incurred in the Company's E-commerce
segment of approximately $3.5 million; and (b) increased selling-based
commissions, compensation and other related selling costs combined ($1.4
million, $500,397 and $22,741, respectively) arising from the expansion of the
E-commerce segment's sales force and selling activities.
Regarding the increase in fee share commissions, during the fiscal year
ended November 30, 2001, the Company significantly expanded the practice of
marketing promotional offers on behalf of its marketing clients ("Clients") to
third party databases on a fee share commission basis. The fee share commission
relationship generally arises after the Company concludes a contractual
arrangement with a Client pursuant to which the Company modifies or develops
the:(i) copy, (ii) offer form and (iii) promotional materials for the Client's
product or service. The Company then tests the promotion, and agrees to deliver
a minimum level of new customers, and/or targeted leads to the Client.
Simultaneously with the execution of these contractual arrangements, the Company
often obtains the rights from the Client to market its promotions to a list of
third parties with whom the Company has marketing relationships (the "Third
Parties"). The Company enters into contracts with each Third Party with whom it
intends to market Client promotions. The terms of these agreements generally
provide that the Third Party has the right to (i) approve the creative materials
for each promotion, (ii) approve the timing of each promotion's mailing, (iii)
terminate the contract on short notice, and (iv) reject any promotion for any
reason. Each agreement also restricts the Third Party from doing business with
the Client other than through the Company for the period of time covered by the
agreement, and sets forth the terms of the Third Party's compensation. Payments
are performance-based only and are either fixed fees paid for each customer or
lead, generated for the Client, or a revenue share that is a percentage of the
revenue generated (after deduction for certain direct costs) by the Company for
marketing that offer to the Third Party database. The Company utilizes unique
Universal Resource Locater identifier links ("URLs") when promotions are mailed
to the Third Party database. It is the unique URL's that form the tracking
mechanism by which the Client reports results to the Company, and the Company is
able to account for revenue generated under the fee share arrangement with Third
Parties.
Selling expenses within the Company's Off-line Marketing Services segment
increased approximately $1.5 million, or 100%, when compared to the prior year's
comparable period. The Company expects that in the remaining quarter of the
fiscal year ending November 30, 2002, it will realize an increase in this
segment's selling expenses based on the anticipated expansion of the operations
of its majority owned subsidiary, Montvale Management LLC, which conducts
business off-line, as well as on-line, as a net branch for licensed mortgage
banking and brokerage companies.
33
CONSOLIDATED GENERAL AND ADMINISTRATIVE EXPENSES, BY SEGMENT, BY COMPONENT
FOR THE PERIODS:
NINE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
E-COMMERCE
Compensation costs and related expenses ......... $ 3,396,693 $1,708,412 $1,688,281 99%
Professional fees ............................... 1,127,033 629,003 498,030 79%
Insurance costs ................................. 345,445 345,496 (51) 0%
Occupancy and equipment costs ................... 238,252 172,105 66,147 38%
Site development, maintenance and
modifications ................................ 706,927 1,340,148 (633,221) -47%
All other G&A expenses .......................... 1,118,968 442,300 676,668 153%
----------- ---------- ---------- -----
TOTAL G&A-- E-COMMERCE SEGMENT .................. $ 6,933,318 $4,637,464 $2,295,854 50%
----------- ---------- ---------- -----
OFF-LINE MARKETING SERVICES
Compensation costs and related expenses ......... $ -- $ 125,929 $ (125,929) -100%
Professional fees ............................... 25,614 -- 25,614 100%
Insurance costs ................................. 2,355 74,035 (71,680) -97%
Occupancy and equipment costs ................... -- 21,513 (21,513) -100%
All other G&A expenses .......................... 1,086,940 49,422 1,037,518 2099%
----------- ---------- ---------- -----
TOTAL G&A-- OFF-LINE SEGMENT .................... $ 1,114,909 $ 270,899 $ 844,010 312%
----------- ---------- ---------- -----
LEC BILLED PRODUCTS AND SERVICES
Compensation costs and related expenses ......... $ -- $ 125,498 $ (125,498) -100%
Insurance costs ................................. -- 74,035 (74,035) -100%
Occupancy and equipment costs ................... -- 21,513 (21,513) -100%
All other G&A expenses .......................... -- 13,973 (13,973) -100%
----------- ---------- ---------- -----
TOTAL G&A-- LEC SEGMENT ......................... $ -- $ 235,019 $ (235,019) -100%
----------- ---------- ---------- -----
CORPORATE AND OTHER
Compensation costs and related expenses ......... $ 1,618,517 $1,600,292 $ 18,225 1%
Professional fees ............................... 704,094 943,251 (239,157) -25%
Insurance costs ................................. 345,792 2,214 343,578 100%
All other G&A expenses .......................... 499,522 388,097 111,425 29%
----------- ---------- ---------- -----
TOTAL G&A-- CORPORATE AND OTHER ................. $ 3,167,925 $2,933,854 $ 234,071 8%
----------- ---------- ---------- -----
CONSOLIDATED TOTALS ............................. $11,216,152 $8,077,236 $3,138,916 39%
=========== ========== ========== =====
General and Administrative expenses ("G&A") on a consolidated basis
increased approximately $3.1 million, or 39%, when comparing G&A of $8.1 million
from the nine months ended August 31, 2001 to G&A of $11.2 million incurred
during the nine months ended August 31, 2002. The net increase was attributable
to (a) the Company's E-commerce segment (approximately $2.3 million, or 73% of
total increase), with such increase related to increased compensation costs,
professional fees and other G&A, offset by a decline in maintenance costs
associated with the Company's web sites, all required to support the 80%
increase in revenues generated by such segment during the nine months ended
August 31, 2002, (b) the Company's Off-line Marketing Services Segment
(approximately $844,010, or 27% of total increase), with such increase related
to G&A necessary to support the segments growth in revenues from $ -0- in fiscal
2001 to approximately $3.5 million during the nine months ended August 31, 2002,
and by (c) other corporate overhead (approximately $234,071, or 7% of total
increase) not specifically identifiable to the Company's operating segments,
with such cost increase including (i) directors and officers liability
insurance, (ii) professional fees incurred in the defense of actions arising
from legacy operations, and (iii) other non-allocable G&A. These overhead
increases were partially offset by an approximate $235,019 decrease in overhead
attributable to the Company's currently inactive LEC Billed Product and Services
segment.
34
BAD DEBT EXPENSE
The Company's bad debt expense for the nine months ended August 31, 2002
was $487,447. The Company did not incur bad debt expense during the nine months
ended August 31, 2001. During the quarter ended November 30, 2001, the credit
profiles of the Company's customer base changed due to the significant downturn
in the Internet advertising and marketing arena, and the inability of the
customers within that arena to procure equity and debt financing to fund deficit
operations. Pursuant to such change in the credit profile of the Company's
customer base, as well as the bankruptcy filing of the Company's significant
service bureau/billing and collection agent, the Company began recording bad
debt expense, and reserving for bad debt exposure at November 30, 2001, and,
accordingly, began to reflect bad debt expense as a separate line item within
the Company's consolidated statement of income during the quarter ended November
30, 2001.
OTHER INCOME (EXPENSE)
The Company's components of "Other income (expense)" for the nine months
ended August 31, 2002 and 2001 are set forth below:
FOR THE PERIODS:
NINE MONTHS ENDED
------------------------- CHANGE CHANGE
AUGUST 31, AUGUST 31, INC (DEC) INC (DEC)
2002 2001 $$$ %%%
----------- ---------- ---------- --------
OTHER INCOME (EXPENSE):
Interest expense ................................. $ (27,633) $ -- $ (27,633) 100%
Interest income and dividends .................... 584,404 1,497,906 (913,502) -61%
Realized gains (losses) on sale of marketable
securities .................................... 85,821 404,061 (318,240) 100%
Permanent impairment charges ..................... -- (4,690,258) 4,690,258 -100%
Other non-operating income:
Talk.com Arbitration Settlement ............... 2,314,121 -- 2,314,121 100%
P.M.Thomas Arbitration Settlement ............. (2,710,000) -- (2,710,000) 100%
Residual revenues from terminated
Programs .................................... -- 84,290 (84,290) -100%
Other miscellaneous income (expense) .......... 48,992 -- 48,992 100%
Liquidation proceeds on prior year
impairment loss ............................. 125,000 -- 125,000 100%
Minority interest (income) loss .................. (279,731) -- (279,731) -100%
----------- ----------- ----------- -----
TOTAL CONSOLIDATED OTHER INCOME (EXPENSE) ........ $ 140,974 $(2,704,001) $ 2,844,975 -105%
=========== =========== =========== =====
Consolidated Other Income(Expense) increased approximately $2.8 million,
from approximately $2.7 million in expense for the nine months ended August 31,
2001 to $140,974 of income for the nine months ended August 31, 2002.
The primary factors contributing to the net increase, in the order of the
table set forth above, are as follows:
(a) a decrease in interest and dividend income of approximately $914,000
resulting from significant decreases in the interest rates available on
short-term commercial paper during the nine months ended May 31, 2002 when
compared with interest rates available for short-term investment during the nine
months ended August 31, 2001;
(b) a decrease in gains realized through sales of marketable securities
approximating $318,000 in the nine months ended August 31, 2002;
35
(c) during the nine months ended August 31, 2002 the Company did not incur
losses from asset impairments. During the nine months ended August 31, 2001 the
Company realized losses, through a permanent impairment, of approximately $4.1
million on marketable securities resulting from significant declines in the
values of such marketable equity securities held in the Company's investment
portfolio, these losses were deemed to be other than temporary. Additionally,
during the nine months ended August 31, 2001, the Company realized a permanent
impairment of $500,051 on a long-term investment that subsequently discontinued
its operations in the third quarter of fiscal 2001. As of the August 31, 2002
balance sheet date, the Company has significantly reduced its exposure to market
fluctuations in its investment portfolio by limiting the contents of such
portfolio to approximately $18.3 million in high grade, short term, commercial
paper and auction rate securities (with yields ranging from 1.80% to 2.56%, with
maturities of 30 to 365 days), and approximately $1.1 million in high risk
investments, consisting of common stock equities and real estate investment
trust equities; and
(d) an increase of $125,000 attributable to liquidation proceeds received
from a prior year long-term investment that was entirely written off through an
impairment charge in the fiscal year ended November 30, 2000.
Additionally, the nine months ended August 31, 2002, included the final
installment related to the Talk.com arbitration victory ($2.3 million) awarded
to the Company in November 2001. Offsetting the Talk.com award was a $2.3
million award granted to the claimants in the Phillip Michael Thomas
arbitration, with an additional payment of $434,418 subsequently negotiated
relating to the award's final release and the discontinuance for the potential
of further civil proceedings.
PROVISION FOR INCOME TAXES
The Company's effective income tax rate is a result of the combination of
federal income taxes at statutory rates, and state taxes, subject to the effects
of valuation allowances taken against the "realizability" of deferred tax
assets. The Company recorded income tax expense of $1,421,245 for the nine
months ended August 31, 2002 on pre-tax income of $3,646,085. This equates to an
effective tax rate of approximately 39%. This effective tax rate is less than
the Company's historically recognized tax rate due to the realization in the
nine months ended August 31, 2002, of previously devalued deferred tax assets
related to capital losses, coupled with the effect of interim period tax
allocation. In the prior comparable period the Company had recorded income tax
expense of $2,109,111 for the nine months ended August 31, 2001 on a pre-tax
profit of approximately $816,728. This effective tax rate relationship is the
result of the Company taking a full valuation allowance during the nine months
ended August 31, 2001, against the future tax benefits attributable to the loss
carryovers arising from permanent impairment charges of $4,690,258 incurred
during such period. This deferred tax asset valuation allowance has been
recorded during the nine months of the fiscal year ended November 30, 2001, due
to the absence of appreciated capital gain property (available for the potential
generation of capital gain income) to offset the net capital losses generated by
the impairment charges.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financial and liquidity position remained strong as exhibited
by the Company's cash, cash equivalents, short-term marketable securities and
marketable equity securities of approximately $39.6 million at August 31, 2002.
Cash, cash equivalents, short-term marketable securities and equity securities
were approximately $38.1 million at November 30, 2001. This increase of
approximately $1.5 million was the result of the Company's collection of
approximately $2.5 million from the final installment on the Talk.com
arbitration award coupled with other cash flows generated from the Company's
operating activities in the approximate aggregate total of $4.9 million, offset
by (1) approximately $2.2 million used in investing activities (comprised of
capital expenditures of $1,618,362 and payments for asset acquisitions, net of
cash received of $548,482); and (2) approximately $1.3 million used in financing
activities (comprised of treasury stock purchases of $2,014,661, net of cash
collected on (a) option exercises of $584,567 and (b) a non-management Section
16-b settlement of $114,403 net of direct costs and after related taxes).
36
Trade accounts receivable at August 31, 2002, as a percentage of net
revenues earned during the three months ended August 31, 2002, was 64%, as
compared to 69%, 77%, and 52% at the end of the comparable three month periods
ended May 31, 2002, February 28, 2002 and November 30, 2001, respectively. The
Company's days-sales-outstanding ("DSO") in accounts receivable at August 31,
2002 were 59 and 56 days for the three and nine month periods ended August 31,
2002, respectively, compared to 91 and 110 days during the prior year's
comparable periods, respectively. The decrease in the current three-month
periods DSO compared to the prior year's comparable periods relates to shortened
collection periods on the outstanding accounts receivables from the Company's
significant customers, as well as the balance of its customer base pursuant to
the Company's continued emphasis on receivables analysis and expedited
collections efforts.
The majority of the Company's customers are extended 30-day credit terms.
The Company continually monitors customer adherence to such terms and constantly
strives to improve the effectiveness of its collection efforts with the goal of
achieving a DSO in the 40-day range. Future fiscal periods might not reflect
this goal of a 40-day DSO, and might exceed the 59 and 56-day DSO's recognized
during the three and nine-month operating periods ended August 31, 2002.
Cash used in financing activities during the nine months ended August 31,
2002 amounted to $1,315,691, and included cash outflows of $2,014,661 for
purchases of the Company's common stock, primarily in open market transactions
and currently held in treasury. It is the Company's intention to retire all
treasury shares in the quarter ending November 30, 2002. Such repurchases were
made in accordance with the Company's stock repurchase plan, pursuant to which
the Board, on June 19, 2002, authorized the Company to repurchase up to two
million shares of its outstanding common stock. Under such plan, the Company
acquired 474,200 shares for $1,857,965, at an average price of $3.92 per share
in open market transactions. Subsequent to the August 31, 2002 balance sheet
date, the Company acquired an additional 83,050 shares at an average price of
approximately $3.48 per share, for a total outlay of $289,366. An additional
39,174 shares were purchased for $156,696, or $4 per share, from the former
owners of Infiknowledge, acquired by the Company in December 2001. The above
referenced financing cash outflows were partially offset by cash proceeds
generated by the exercise of the Company's stock options, which amounted to
approximately $585,000, and approximately $114,000 in proceeds (net of related
costs and income taxes) related to an insider trading action brought against a
former non-management insider, pursuant to which such insider was required to
return his deemed insider trading gains to the Company.
Historically, the Company's primary cash requirements have been used to
fund the cost of advertising and promotion, with additional funds having been
used in the purchasing of equipment and services in connection with the
commencement of new business lines, further development of businesses being test
marketed and for the development of the equipment infrastructure of newly formed
subsidiaries resulting from asset purchases.
During the fiscal year ended November 30, 2000, the Company executed its
on-line direct marketing strategy. The Company's future plans and business
strategy continue to call for its Internet based E-commerce segment to be its
primary operating focus, with such segment generating a material portion of
future revenues. If the Company's on-line activities fail to generate sufficient
revenue, then the continuation of the Company's year over year on-line growth
could have a material adverse impact on the Company's capital and liquidity
resources relating to possible expenditures for (a) marketing campaigns, (b)
product development costs, (c) site development and maintenance and related
technology based costs, (d) potential on-line, and/or off-line, business
acquisitions, (e) costs associated with developing alternative means of email
promotion delivery, or (f) other unexpected and/or currently unidentifiable
costs. During the nine months ended August 31, 2002, the Company expended
approximately $1.6 million in capital expenditures to support its E-commerce
activities. Obsolescence, changes in the Internet operating landscape,
government regulation and/or other unexpected events impacting Internet direct
marketing, or the economy in general, could individually, or in combination have
an adverse effect on the carrying value of the capital expenditures procured in
fiscal 2002, as well as the carrying value of other asset acquisitions made in
fiscal 2002 and earlier that have not yet been fully depreciated or amortized.
37
In December 2001, the Company acquired the assets of InfiKnowledge, a
closely held private Canadian based Internet technology company. The Company
continues to believe that this acquisition will decrease certain costs relative
to its reliance on third parties in the provision of emailing services and other
Internet hosting services. The realization of those proposed cost savings
require capital expenditures by the newly formed entity, with the funding of
such expenditures being provided by the Company. To date such capital
expenditures approximated $1.2 million.
During the six-month period, March 1, 2002 to August 31, 2002, the Company
experienced problems with the delivery of its email promotional offers. Such
problems reduced revenue and income from the E-Commerce sub-segment. The Company
has addressed the issue by deploying new reinforced delivery platforms with
increased redundancy and expanded diversification using both internal and
external emailing resources. The Company currently believes that the significant
component of the email delivery problem is attributable to Internet Service
Providers that unilaterally block commercial emails from reaching their consumer
subscribers. Although the Company has conceived of a number of programs to
address this specific problem, there can be no assurance that any of these
programs will work effectively, or can be timely implemented.
Any further changes in the Internet operating landscape that materially
hinders the Company's current ability and/or cost to deliver commercial email
messages to the consumer records in its databases, and the consumer records in
the databases of its affiliates, could potentially cause a material impact on
net revenue and gross margin and, therefore, its profitability and cash flows
could be adversely affected. Various state laws exist, and federal legislation
is currently pending, that limit the Company's ability to deliver commercial
e-mail messages to consumers. There are presently no federal laws that regulate
sending unsolicited email. The pending federal bills and existing state laws
require that certain "opt-out" procedures be included in emails and prohibit
"false routing" or "fictitious address" information. Existing state, and pending
federal, laws require functioning return e-mail addresses and that valid postal
addresses be included by the senders of commercial email messages. Some states
require an "ADV" label in the subject line, and proscribe false header or
misleading subject lines. Attorneys General and/or consumers are given authority
to enforce the state laws. States with legislation affecting the sending of
unsolicited commercial email include: Arkansas, California, Colorado,
Connecticut, Delaware, Idaho, Illinois, Iowa, Louisiana, Maryland, Missouri,
Nevada, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South
Dakota, Tennessee, Utah, Virginia, Washington, West Virginia and Wisconsin. If
strict federal legislation is subsequently written into law, with its terms
specifically limiting the Company's ability to market its offers, the Company
could potentially realize a material adverse impact in future fiscal period net
revenue growth, and therefore, profitability and cash flows could be adversely
affected.
Should the business climate, Internet operating environment or technology
environment change significantly, the Company could be faced with circumstances
that would limit or prevent its utilization of these capital expenditures.
The Company expended approximately $200,000 in cash for the Infiknowledge
asset acquisition (net of cash received of approximately $63,000). The Company
is also required to expend an additional $200,000 on December 6, 2002, regarding
the final cash installment related to the InfiKnowledge asset acquisition.
In December 2001, the Company also acquired the assets of ThanksMuch.com, a
closely held private company for approximately $361,000 (net of cash received of
approximately $74,000). The Company does not anticipate that this asset
acquisition will require significant capital expenditures to maintain, or
improve its operations.
In September 2002, the Company disbursed $2,710,000 in final settlement of
an arbitration award. The total payments made exceeded the award by
approximately $435,000. The excess related to an additional settlement agreement
that precludes the claimants from further proceeding with the action in civil
court. The total disbursement of $2.7 million was accrued at August 31, 2002,
and reflected on the income statement as a component of "Other non-operating
income(expense)" for the nine months ended August 31, 2002. The civil action
settlement portion was included as a component of "Other non-operating income
(expense)" during the three months ended August 31, 2002. The arbitration award,
including related interest expense, was included in the three and six-month
periods ended May 31, 2002.
38
The Company has received tentative notice regarding the final payment to
the Internal Revenue Service for tax audits covering the years 1996 to 1998. The
tentative notice of final settlement approximates $900,000, and includes
unbilled interest expense on such tax audits. The Company had provided for the
income statement impact of such outlay in a prior year and therefore does not
expect the payment, which is planed to be made in the quarter ending November
30, 2002, to impact earnings.
During the fiscal year ended November 30, 1999, the Company's Internet
business plan and strategy prompted the Company to terminate the active
marketing of its legacy products and services. Accordingly, this legacy activity
may contribute, but in a significantly decreasing degree, to the Company's cash
flows and net income in subsequent fiscal periods, as was the case during the
year ended November 30, 2001 when compared to the years ended November 30, 2000
and 1999. This should be considered when using the Company's historical results
in evaluating future operations, cash flows and financial position.
Nevertheless, the Company will continue to explore opportunities to offer other
Off-line Marketing Services and LEC Billed Products and Services in the future.
Under current operating plans and assumptions, management believes that
projected cash flows from operations and available cash resources will be
sufficient to satisfy the Company's anticipated cash requirements for at least
the next twelve months. Currently, the Company does not have any material
long-term obligations other than those described in the note "Commitments and
Contingent Liabilities" included in the Company's financial statements included
in this document, nor has the Company identified any long-term obligations that
it contemplates incurring in the near future. As the Company seeks to further
extend its reach into the E-commerce arena, as well as identify new and other
consumer oriented products and services in the off-line arena, the Company may
use existing cash reserves, long-term financing, or other means to finance such
diversification.
TRANSACTIONS WITH MAJOR CUSTOMERS
During the three and nine months ended August 31, 2002, the Company had
five major customers in its E-commerce segment, which in combination accounted
for approximately $5.2 million and $18 million of consolidated net revenue,
respectively, or 49% and 53% of consolidated net revenues, respectively.
Approximately $4.5 million, or 65% of consolidated net accounts receivable was
attributable to such major customer group as of August 31, 2002. For the three
and nine months ended August 31, 2002, one of the five customers referenced
above had related net revenues that equaled or exceeded 10% of the Company's
consolidated net revenue for such period. The five major customers referenced
above accounted for 24%, 7%, 7%, 6% and 5% of consolidated net revenue,
respectively, for the three months ended August 31, 2002, and 25%, 8%, 8%, 7%
and 5% of consolidated net revenue, respectively, for the nine months ended
August 31, 2002. Of the remaining approximate 100 active customers in the three
and nine months ended August 31, 2002, no other single customer had net revenue
that equaled or exceeded 2% of consolidated net revenue.
The Company continued to conduct business with all such five major
customers as of October 8, 2002. The customer which occupied 25% of the
Company's net revenue for the nine months ended August 31, 2002 has notified the
Company that it is exercising its right to terminate its agreement with the
Company and, as such, will phase out its business with the Company over a ninety
day period ending December 7, 2002. See "-- Three Months Ended August 31, 2002
and August 31, 2001 -- Net Revenues" for a more detailed discussion of the
impact of such termination on the Company's operations and cash flows.
During the three and nine months ended August 31, 2001, the Company had
four customers in its E-commerce segment which, in combination, accounted for
approximately 50.6% and 47.4% of consolidated net revenues, respectively, and
approximately 30.8% of consolidated net accounts receivable as of August 31,
2001.
CRITICAL ACCOUNTING POLICY AND ACCOUNTING ESTIMATE DISCUSSION
In accordance with the Securities and Exchange Commission's (the
"Commission") Release Nos. 33-8040; 34-45149; and FR-60 issued in December 2001,
referencing the Commission's statement "regarding the selection
39
and disclosure by public companies of critical accounting policies and
practices", the Company has set forth below what it believes to be the most
pervasive accounting policies and estimates that could have a material effect on
the Company's results of operations and cash flows if general business
conditions or individual customer financial circumstances change in an adverse
way relative to the policies and estimates used in the attached financial
statements or in any "forward looking" statements contained herein.
FACTORS THAT COULD EFFECT FUTURE RESULTS
REVENUE RECOGNITION, VARIABLE COSTS AND BAD DEBTS
The Company currently earns the most significant portion of its revenue
from the E-commerce segment pursuant to marketing agreements with marketing
partners and corporate customers (collectively, "Corporate Customers"). The
provisions of each agreement determine the type and timing of revenue to be
recorded. The Company invoices its customers in accordance with the terms of the
underlying agreement. Revenue is recognized at the time the marketing activity
is delivered, or service is provided, net of estimated contractually specified
data qualification allowances, when applicable. Such data qualification
allowances may include duplications, invalid addresses, age restrictions and
allowances, and are recorded as contra revenue. The Company's revenues are
adjusted in later fiscal periods if the Company's actual allowances vary from
amounts previously estimated. Historically, the variance between actual
allowances and previously estimated allowances has been immaterial. If events
were to occur that would cause the Company's actual allowances (which are
recorded as offsets against gross revenue, as contra-revenues, in arriving at
reported net revenue) to vary significantly from those originally estimated and
reflected in the financial statements, the Company could suffer material
deterioration in future fiscal period gross margins, and, therefore, our
profitability and cash flows could be adversely affected.
Certain obligations are recorded at the time revenue is recognized. They
include costs payable to other on-line, as well as off-line, advertisers for
registered user acquisitions and consumer data, fee sharing costs under third
party database use agreements, email message delivery costs, contingent based
prize indemnification coverage (for potential free on-line lottery winners),
premium fulfillment costs related to the respective promotion and all other
variable costs directly associated with completing the Company's obligations
relative to the revenue being recognized.
Should the Internet operating landscape affecting the Company adversely
change resulting in (a) higher costs of acquiring consumer data and registered
users for the Company's websites; (b) higher costs of acquiring data for our
marketing partners, compromising such marketing partners' ability to maintain
adequate databases to allow for continued third party database use agreements;
(c) the Company's fiscal 2002 InfiKnowledge asset acquisition failing to reduce
the cost of the Company's email delivery activities and other web hosting
service costs, or the Company being required to depend on third party emailing
service bureaus to provide an increased portion of its commercial email delivery
at a cost in excess of anticipated internally generated costs, or other third
party influence on the Company's ability to deliver email messages to the
records in its databases, or the records in its marketing affiliates' databases;
(d) the Company's contingent based prize indemnification premiums for
indemnification coverage increasing due to an increase in the number of prize
winners at the site, as a result of the insurance industry in general, or other
currently unknown factors; (e) the Company's accruals for fulfillment
obligations arising out of its promotions proving to be less than the actual
redemptions processed in subsequent fiscal periods; or (f) unpredictable
technology changes or commercial technology applications; then, if any one, or a
combination, of the above factors were to materialize in subsequent fiscal
periods, the Company could suffer material deterioration in future fiscal period
revenue growth and gross margins, and therefore, our profitability and cash
flows could be materially adversely affected.
Revenue recognition is also subject to provisions based on the probability
of collection of the related trade accounts receivable. We continuously evaluate
the potential of the collectibility of trade receivables by reviewing such
factors as deterioration in the operating results, financial condition, or
bankruptcy filings, of our customers. As a result of this review process, we
record bad debt provisions to adjust the related receivables' carrying amount
40
to an estimated realizable value. Provisions for bad debts are also recorded due
to the review of other factors, including (a) the length of time the receivables
are past due, (b) historical experience, and (c) other factors obtained during
the conduct of collection efforts. If circumstances change regarding our
specific customers on an individual basis, or if demand for Internet direct
marketing softens, or if a continuation of the current global economic downturn
prevails, our estimates for bad debt provisions could be further increased,
which could adversely affect our operating margins, our profitability and our
cash flows.
CONTINUATION OF MAJOR CUSTOMERS, LOSS OF MAJOR CUSTOMER, AND PROSPECTS OF
MAJORITY-OWNED SUBSIDIARY
During the three and nine months ended August 31, 2002, the Company had
five major customers in its E-commerce segment, which in combination accounted
for approximately $5.2 million and $18 million of consolidated net revenue,
respectively, or 49% and 53% of consolidated net revenues, respectively.
Approximately $4.5 million, or 65% of consolidated net accounts receivable was
attributable to such major customers as of August 31, 2002. For the three and
nine months ended August 31, 2002, one of the five customers referenced above
had related net revenues that equaled or exceeded 10% of the Company's
consolidated net revenue for such period. The five major customers referenced
above accounted for 24%, 7%, 7%, 6% and 5% of consolidated net revenue,
respectively, for the three months ended August 31, 2002, and 25%, 8%, 8%, 7%
and 5% of consolidated net revenue, respectively, for the nine months ended
August 31, 2002. Of the remaining approximate 100 active customers in the three
and nine months ended August 31, 2002, no other single customer had net revenue
that equaled or exceeded 2% of consolidated net revenue.
The Company continued to conduct business with all such five major
customers as of October 8, 2002. The customer which occupied 25% of the
Company's net revenue for the nine months ended August 31, 2002 has notified the
Company that it is exercising its right to terminate its agreement with the
Company, and, as such, will phase out its business with the Company over a
ninety day period ending December 7, 2002. This customer loss has been deemed
immaterial at the Company's operations level due to the fact that the operating
margin earned from such activity was less than that recognized from the
Company's other marketing activities and the Company believes that it will be
able to use its media channels, creative department and senior management's
time, all of which, it believes, was disproportionately dedicated to this
customer, more profitably by generating additional sales for other current
customers with large demands, improving results of existing customer
relationships and developing new relationships and proprietary products and
services. The Company expects an immaterial decline in future fiscal period
revenues related to such termination, and looks to realize improved margins at
both the contribution and operating level. Additionally, the Company anticipates
that it will recognize improved contribution and operating margins in future
fiscal quarters due to the reduction in the Company's cost of sales that is
expected to arise from the elimination of fulfillment costs as they relate to
the termination of this contract. Pursuant to the terms of the Company's
agreement with this terminating customer, during the 90-day phase out period,
the customer is only required to accept certain levels of sales generated by the
Company on its behalf, based on a percentage of sales recorded in the thirty day
period prior to the delivery of the termination notice. Therefore, the Company
will recognize revenue under this terminated agreement during the quarter ending
November 30, 2002.
Should the Company not be able to continue conducting business with the
balance of its significant customers, or maintain said relationships with such
companies on equivalent, or similarly favorable terms; or replace the loss of
the significant income generated by the lost customer pursuant to the Company's
above-discussed expectations; or replace any of the other significant customers
with other third parties on similar revenue and gross margin generating terms,
the Company could suffer material deterioration in future fiscal period revenue
growth and gross margins and, therefore, our profitability and cash flows would
be adversely affected. Our potential decreased profitability relative to such
possible failure to continue current relationships, or our inability to replace
them with new relationships, could be partially mitigated by the execution of
reductions in our workforce and other downsizing cost reducing measures. It is
not known how rapidly the Company could respond with such reductions, if at all.
41
During the three and nine-month periods ended May 31, 2002, the Company's
51% majority-owned subsidiary, Montvale Management LLC, contributed
approximately $1.4 and $2.2 million, or 17.6% and 12.2%, respectively, of
consolidated net revenues. The subsidiary became active in Fiscal 2001 (in the
Company's fourth quarter). The subsidiary generates revenue by operating under
net branch agreements, whereby it originates residential mortgages and
refinancings for licensed mortgage banking and brokerage companies under such
net branch agreement. The subsidiary business activity increased in Fiscal 2001
as a result of reduced mortgage and refinance loan interest rates, and increased
government funds for low-income homebuyers. The Company's future business plans
and operating assumptions anticipate that the subsidiary will contribute an
increasing amount of revenue to the Company in terms of absolute dollars, and in
terms of percentage of total revenues and operating income, during the final
quarter of the fiscal year ending November 30, 2002. Such assumptions are
subject to the continuation of the current interest rate market which favors
refinancings, the continued acceptance by the general public of off-line and
on-line marketing promotions for mortgage and mortgage related products, the
continued ability of the independently operated majority-owned subsidiary to
hire and maintain competent staff and management personnel, trained in the
specific field of net branch operations, as well as other factors currently not
identifiable. The Company can make no assurance that it will realize an
increased contribution of revenue and related profits from the majority owned
subsidiary in future fiscal periods.
The Company's revenues and profitability from operations have historically
varied. Our revenues, cost of providing revenues, profit margins and overhead
expenses have varied historically among segments, as well as on a consolidated
basis. The revenue allocation among our segments in future periods will most
probably be different than our current revenue allocation due to several
factors, including consumer tastes and potential regulatory issues that may
exist in future periods and other currently unknown factors that could restrict
the Company's revenue generating cycle or cost structure. Therefore, it is
difficult to predict revenue and gross margin trends. Actual trends may cause
the Company to adjust its operating emphasis, which could result in continued
period-to-period fluctuations in the Company's results of operations.
Historically, the Company has had to react to rapid changes in the business
environment within which it operates. Management responded to these rapid
changes as deemed appropriate at the time of change, and as dictated by the
nature of such changes. Management's reaction to such changes covered a broad
range of business related adjustments, ranging from product mix repositioning
and staff reductions, to entire business model overhauls. Based on the Company's
current operations and marketing methods, as well as the still emerging status
of the Internet marketing environment, it is possible that management could
institute significant changes to the Company's business model in response to
unforeseen rapid changes in future fiscal periods.
IMPAIRMENT OF GOODWILL, OTHER INTANGIBLES AND INVESTMENT PORTFOLIOS COULD
IMPACT NET INCOME
The Company carries Goodwill and other Intangibles on its balance sheet
arising from current and prior year acquisitions. The Company must review, at
least annually, such Goodwill and other Intangibles for any asset impairment. If
the review of the Company's Goodwill and Intangibles related to the subsidiaries
organized to acquire such assets determine that such assets are impaired, then
the Company will be required to recognize an impairment charge on such Goodwill
necessary to reduce the carrying value of the Goodwill to its net realizable
value. Should events occur that would give rise to such impairment charge, the
Company would recognize decreased profitability to the extent of such
adjustment. Cash flows would not be directly affected by the impairment charge,
but cash flows would, most likely, be adversely affected as a result of the
facts and circumstances that created the impairment charge.
MARKET FLUCTUATION AND DEBT REPAYMENT RISK OF MARKETABLE SECURITIES
INVESTMENT PORTFOLIO
The Company maintains an investment portfolio that is managed by prominent
financial institutions. The portfolio includes high-grade corporate commercial
paper and auction rate securities, equity securities of real estate investment
trusts ("REITs") and common stock equities, all of which are held for varying
periods of time, pursuant to maturity dates, market conditions and other
factors. The values of our investments in the common stock of publicly-traded
companies, which as of August 31, 2002 amounted to approximately $1.1 million,
and are subject to significant market price volatility, in addition to the
potential for business failure at the company level.
42
Moreover, due to the economic downturn and difficulties that may be faced
by some of the companies in which we have investments, our investment portfolio
could be further impaired by the failure of such companies in fulfilling their
responsibility of adhering to the repayment of principal upon maturity.
Additionally, the Company's cash flows and interest income could be
negatively impacted from continued Federal Reserve Bank interest rate
reductions.
POTENTIAL OF FEDERAL, AND/OR STATE ENACTED LEGISLATION
Any further changes in the Internet operating landscape that materially
hinders the Company's current ability and/or cost to deliver commercial email
messages to the consumer records in its databases, and the consumer records in
the databases of its affiliates, could potentially cause a material impact on
net revenue and gross margin and, therefore, its profitability and cash flows
could be adversely affected. Various state laws exist, and federal legislation
is currently pending, that limit the Company's ability to deliver commercial
e-mail messages to consumers. There are presently no federal laws that regulate
sending unsolicited email. The pending federal bills and existing state laws
require that certain "opt-out" procedures be included in emails and prohibit
"false routing" or "fictitious address" information. Existing state, and pending
federal, laws require functioning return e-mail addresses and that valid postal
addresses be included by the senders of commercial email messages. Some states
require an "ADV" label in the subject line, and proscribe false header or
misleading subject lines. Attorneys General and/or consumers are given authority
to enforce the state laws. States with legislation affecting the sending of
unsolicited commercial email include: Arkansas, California, Colorado,
Connecticut, Delaware, Idaho, Illinois, Iowa, Louisiana, Maryland, Missouri,
Nevada, North Carolina, Ohio, Oklahoma, Pennsylvania, Rhode Island, South
Dakota, Tennessee, Utah, Virginia, Washington, West Virginia and Wisconsin. If
strict federal legislation is subsequently written into law, with its terms
specifically limiting the Company's ability to market its offers, the Company
could potentially realize a material adverse impact in future fiscal period net
revenue growth, and therefore, profitability and cash flows could be adversely
affected.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
The Company's chief executive officer and its chief financial officer,
after evaluating the effectiveness of the Company's disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c) and 15-d-14(c) as of a
date within 90 days of the filing date of the quarterly report (the "Evaluation
Date") have concluded that as of the Evaluation Date, the Company's disclosure
controls and procedures were adequate and effective to ensure that material
information relating to the Company and its consolidated subsidiaries would be
made known to them by others within those entities, particularly during the
period in which this quarterly report was being prepared.
(b) Changes in internal controls.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect the Company's disclosure controls
and procedures subsequent to the Evaluation Date, nor any significant
deficiencies or material weaknesses in such disclosure controls and procedures
requiring corrective actions. As a result, no corrective actions were taken.
43
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
1. NANCY GAREN-- On or about October 16, 2001, Nancy Garen, author of
"Tarot Made Easy", commenced an action against a series of defendants, including
the Company, in the United States District Court for the Central District of
California, entitled NANCY GAREN V. STEVEN L. FEDER, PETER L. STOLZ, THOMAS H.
LINDSEY, GALACTIC TELCOM, INC., ACCESS RESOURCE SERVICES, INC., PSYCHIC READERS
NETWORK, INC. D/B/A MISS CLEO, OSHUN 5 COMMUNICATIONS, INC., CIRCLE OF LIGHT,
INC., CENTRAL TALK MANAGEMENT, INC., TRAFFIX, INC., WEKARE READERS &
INTERPRETERS, INC., WEST CORPORATION, AND DOES 1 THROUGH 10 (EDCV 01-790
(VAP-SGLx)). Plaintiff alleges that defendants are liable for a copyright
infringement, contributory copyright infringement, vicarious copyright
infringement, unfair competition, contributory federal unfair competition and
state statutory and common law unfair competition, and further requests a
constructive trust, a temporary restraining order, and damages from alleged
infringement of a copyright or, alternatively, statutory damages for each act of
infringement in "an amount provided by law in excess of $250,000,000", all as
the same may have arisen from the defendants' marketing of tarot card reading
and other psychic services. The Company does not believe that there is any merit
to Ms. Garen's claims as they relate to the Company, has denied the claims in
its answer to the complaint, and intends vigorously to defend against the
claims.
2. MAVIES WINGLER -- On or about May 9, 2001, Mavies Wingler commenced an
action against Group Lotto, Inc. ("GLI"), a wholly-owned subsidiary of the
Company, in the Circuit Court of Logan County, West Virginia. Ms. Wingler claims
to have picked the winning numbers entitling her to $10 million. On June 8,
2001, the action was removed to the United States District Court, Southern
District of West Virginia, and is entitled Wingler v. GroupLotto, Inc., Docket
Number 2:01 -- CV -- 518. The action is in the discovery stage. The Company does
not believe that there is any merit to Ms. Wingler's claim, and intends
vigorously to defend against it. The Company and GLI have a contract of
indemnification with SCA Promotions, Inc. to be indemnified for prizes paid out
to qualified winners. GLI winners are required to produce the Group Lotto Entry
Notification form ("GLEN") within a specified period of time after matching a
drawing's winning numbers in order to qualify for receipt of the appropriate
prize winnings.
3. DANIEL RODGERS -- In March, 2002, Daniel Rodgers commenced an action
against the Company in Supreme Court of the State of New York, Rockland County.
The complaint alleges that the Company disseminated false and misleading
advertisements through email advertisements and through the website of its
subsidiary, GroupLotto.com. Mr. Rodgers purports to represent a class consisting
of those who, during the period January 1, 2001 to March 5, 2002, provided their
name, address, email address and other biographical information in response to
the email advertisements or in response to the GroupLotto web page. The
Complaint purports to allege claims of common law fraud, deceptive acts and
practices, and false and misleading advertising under New York law. The
Complaint seeks injunctive relief, unspecified monetary damages, and attorney's
fees. The Company believes that there is no merit to the claims, has filed a
motion to dismiss the complaint, which motion is pending before the court, and
otherwise intends vigorously to defend against the claims.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS
A Proxy Statement was mailed on or about July 17, 2002 to shareholders of
record of the Company as of July 9, 2002 in connection with the Company's 2002
Annual Meeting of Shareholders, which was held on August 15, 2002 at the
Company's executive offices, One Blue Hill Plaza, Pearl River, New York. At the
Meeting, the shareholders voted on three matters, all of which were approved.
44
The first matter was the election of the members of the Board of Directors.
The seven directors elected and the tabulation of the votes (both in person and
by proxy) were as follows:
NOMINEES FOR DIRECTORS FOR AGAINST WITHHELD
- ---------------------- --- ------- --------
Jeffrey L. Schwartz 11,371,907 539,803 0
Andrew Stollman 11,371,907 539,803 0
Eric Aroesty 11,371,907 539,803 0
Murray L. Skala 11,371,907 539,803 0
Edwin Levy 11,371,907 539,803 0
Lawrence Burstein 11,371,907 539,803 0
Jack Silver 11,371,907 539,803 0
There were no broker held non-voted shares represented at the Meeting with
respect to this matter.
The second matter upon which the shareholders voted was the proposal to
ratify the appointment by the Board of Directors of PricewaterhouseCoopers LLP
as independent certified public accountants for the Company for 2002. The
tabulation of the votes (both in person and by proxy) was as follows:
FOR AGAINST ABSTENTIONS
--- ------- -----------
11,904,812 3,553 3,345,0003
There were no broker held non-voted shares represented at the Meeting with
respect to this matter.
The third matter upon which the shareholders voted was the proposal to
ratify and approve the Company's Fourth Amended and Restated 1996 Stock Option
Plan, amending the Company's Third Amended and Restated Stock Option Plan by
increasing the maximum number of shares of the Company's Common Stock for which
stock options may be granted thereunder from 4,850,000 to 5,350,000 shares. The
tabulation of the votes (both in person and by proxy) was as follows:
FOR AGAINST ABSTENTIONS
--- ------- -----------
9,914,525 1,687,280 309,905
There were no broker held non-voted shares represented at the Meeting with
respect to this matter.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS.
EXHIBIT
NUMBER
- --------
3.1.1 Articles of Incorporation of the Company, as amended (1)
3.1.2 Amendment to the Articles of Incorporation of the Company (2)
3.2 By-Laws of the Company (3)
99.1 Written Statement of the Chief Executive Officer, Pursuant to 18 U.S.C.
Section 1350*
99.2 Written Statement of the Chief Financial Officer, Pursuant to 18 U.S.C.
Section 1350*
- -----------
* Filed herewith.
(1) Filed as an Exhibit to the Company's Registration Statement on Form 8-A,
dated October 23, 1995, and incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended August 31, 1998, and incorporated herein by reference.
45
(3) Filed as an Exhibit to the Company's Registration Statement on Form S-1
(the "S-1 Registration Statement"), dated September 6, 1995 (File No.
33-96632), and incorporated herein by reference.
(B) REPORTS ON FORM 8-K.
The Company did not file any reports on Form 8-K during the third quarter
of the fiscal year ending November 30, 2002.
FORWARD LOOKING INFORMATION
This Quarterly Report on Form 10-Q includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. When used herein, words like "intend,"
"anticipate," "believe," "estimate," "plan" or "expect," as they relate to the
Company, are intended to identify forward-looking statements. The Company
believes that the assumptions and expectations reflected in such forward-looking
statements are reasonable, based on information available to it on the date of
this Quarterly Report, but no assurances can be given that these assumptions and
expectations will prove to have been correct or that the Company will take any
action that it may presently be planning. The Company is not undertaking to
publicly update or revise any forward-looking statement if it obtains new
information or upon the occurrence of future events or otherwise.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TRAFFIX, INC.
By: /s/ JEFFREY L. SCHWARTZ
--------------------------------------
Jeffrey L. Schwartz
Chairman and CEO
Date: October 15, 2002
By: /s/ DANIEL HARVEY
--------------------------------------
Daniel Harvey
Chief Financial Officer
(Principal Financial Officer)
Date: October 15, 2002
46
CERTIFICATIONS
I, Jeffrey L. Schwartz, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Traffix, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors:
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: October 15, 2002
By: /s/ JEFFREY L. SCHWARTZ
------------------------------------
JEFFREY L. SCHWARTZ
Chairman and Chief Operating Officer
47
I, Daniel Harvey, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Traffix, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of the registrant's board of directors:
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: October 15, 2002
By: /s/ DANIEL HARVEY
-----------------------
DANIEL HARVEY
Chief Financial Officer
48
EXHIBIT INDEX
EXHIBIT
NUMBER
-------
3.1.1 Articles of Incorporation of the Company, as amended (1)
3.1.2 Amendment to the Articles of Incorporation of the Company (2)
3.3 3.2 By-Laws of the Company (3)
99.1 Written Statement of the Chief Executive Officer, Pursuant to 18 U.S.C.
Section 1350*
99.2 Written Statement of the Chief Financial Officer, Pursuant to 18 U.S.C.
Section 1350*
- ---------------
* Filed herewith.
(1) Filed as an Exhibit to the Company's Registration Statement on Form 8-A,
dated October 23, 1995, and incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the
fiscal quarter ended August 31, 1998, and incorporated herein by reference.
(3 ) Filed as an Exhibit to the Company's Registration Statement on Form S-1,
dated September 6, 1995 (File No. 33-96632), and incorporated herein by
reference.
49